Time to Take a Brazilian Chill Pill

I have been a big fan of Brazil since reading Jim O’Neil’s “Dreaming with BRICs” back in 2005/06.  The thesis is simple – Brazil has an abundance of natural resources Iron Ore, Nickel, Copper, Oil and you know who (China) needs as much as can be supplied.  Initially, I invested in the theme thru PetroBras (oil), Vale (iron ore, nickel) and occasionally the Brazilian ETF (EWZ).

Over time my emphasis shifted from the commodity plays to the domestic ones.  As people feel better about the economy their propensity to spend increases.  The Brazilian small cap ETF (BRF) became my investment vehicle of choice when it debuted in May 2009.  The fund invests in retailers, home builders, banks and other industries tied to domestic demand.

BRF has significantly out performed the other vehicles since its inception. Brazil’s unemployment rate reported in December was 5.3% nearly half of the average rate from 2001 to 2010.  Most likely BRF will remain my go to stock.

Brazil’s fundamental story extends beyond China.  The country will also be hosting the 2014 World Cup and the 2016 Olympics. Both events will drive significant investments.  I realize that buy and hold is no longer in vogue, but dropping a bucket of money and forgetting in Brazil is tempting.  Matter of fact, I have been essentially long BRF since June ’09 with the exception of a few days here and there.  However, last Tuesday I sold BRF and I may not be buying it back for awhile.

Last week the Brazilian government released an inflation report showing a rise in the annual inflation rate to 6.04% (WSJ).  This is creeping closer to the government’s 2011 upper limit of 6.5%.  Under Brazil’s inflation-targeting program, the Brazilian Central Bank is obliged to take steps whenever inflation threatens to burst out of the band. Such steps usually involve interest rate hikes.  Higher interest rates will likely siphon investment money away from stocks and into fixed-income investments.

On cue, stocks have started selling off.   There was a time when I dreaded sell-offs.  However, if you don’t ride a sell-off down; there is nothing to dread.

The past eight years have seen over 20 million Brazilians lifted from poverty.  The government is not going to let inflation get out of control and stamp out this recovery.  That being said, they can’t stifle growth.  The World Cup and Olympics dates are not changing.  I expect the government to be very vigilant over the next 6 months to a year.  First hint that the rate hike cycle is over – I’m back in.

Disclosure:  At the time of this writing, I have no position in any stocks mentioned.  That can change at any time.

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