Brazil ETFs’ Curious Rally

Brazilian equity ETFs are rallying sharply, with some funds landing among top-performing ETFs in the past month.

The question is, why?

There are three ETFs on the market today that offer long exposure to Brazil’s total equity market, and they have delivered anywhere from 11% to 17% in gains in the past month alone.

They are the newcomer Franklin FTSE Brazil ETF (FLBR), the veteran iShares MSCI Brazil ETF (EWZ) and the smart-beta First Trust Brazil AlphaDEX Fund (FBZ). Their respective performance is, in some cases, more than three times the returns of a broad emerging market ETF such as the iShares Core MSCI Emerging Markets ETF (IEMG), which has Brazil at about 6% of the portfolio.

These are the same ETFs that have struggled to find much upside all year, as Brazil struggles with steep currency weakness, political turmoil, corruption scandals, productivity losses linked to trucker strikes, and concerns over global trade centered on U.S.-China tariff disputes.

Going back to the beginning of 2018, FLBR, EWZ and FBZ—as well as the broad emerging market fund—are all in the red:

Is the last 30-day performance the beginning of a turnaround for South America’s largest economy, or is this recent bout of strength simply a short-lived bump in the road?

Unfortunately, there seems to be no consensus on what comes next.

Split Opinions

Some say recent strength could be simply a matter of valuation. Single-country investor Dave Garff, head of Accuvest, argues Brazil still faces “poor and deteriorating fundamentals, poor momentum and high risk.” According to him, Brazil sits near the bottom of Accuvest’s single-country rankings—and has been there a while.

“The [Brazilian] real got absolutely hammered over the last several months,” Garff said. “Obviously momentum has changed recently, but one month is not enough for us to get a signal that things have changed there.”

Accuvest has not owned any Brazil equity ETFs in months, and Garff says the recent performance of these total market ETFs doesn’t suggest that it should. On the contrary, investors may be simply bargain-hunting as valuations bottomed in July.

It could also reflect some improved expectations for the upcoming election in Brazil, where recent polls suggest a “centrist” candidate could now win, Garff said—a positive for markets. But he says the bigger picture remains unflattering for Brazil, with fundamentals grim. 

On the other side, market strategists like J.P. Morgan’s Emy Shayo, see reason to be moderately bullish on Brazil.

Over the weekend, Barron’s reported that Shayo sees Brazil benefiting from a strengthening earnings outlook and an improving political environment.    

“Corporate earnings look set to slough off a recent 10-day truckers’ strike that helped cut expected 2018 gross-domestic-product growth from 2.6% to 1.6%. Second-quarter profits at listed companies will jump 57% year-over-year, the bank predicts, which could propel Brazilian stocks up by another 8%,” Barron’s reported Shayo as saying.

Like Shayo, Jorge Mariscal, CIO for emerging markets at UBS Wealth Management, also sees reason to be hopeful that Brazil will see much-needed reform, but unlike Shayo, he says it’s too early to say things are good, according to Barron’s.

Entry Point?

Either way, a fund like EWZ—the market’s largest exchange-traded portfolio of Brazil equities, with $7 billion in total assets—saw its share price earlier this month drop to its lowest levels since late 2016. To some, this may be value and a buying opportunity.

But the lack of clear direction for Brazil ahead could by and large explain why investors have not yet jumped into this recent rally. The three ETFs focused on the country have actually seen modest net outflows in the past 30 days.

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Contact Cinthia Murphy at [email protected]