Category: Emerging Markets

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.

US based investors have enjoyed the last few weeks, but Emerging Market investors have been lighting it up all summer.  Bespoke Investment Group posted an interesting chart on their blog on yesterday.  The chart shows the relative strength of the the MSCI Emerging Market ETF (EEM) compared to the S&P 500 ETF (SPY).  In the chart, a rising line indicates Emerging Markets are outperforming while a falling line indicates under performance.

With concerns over sovereign debt elevated this year, Emerging Markets – which have little of it, should have easily outperformed.  However, that wasn’t the case in the first half of the year.  Bespoke identified and reported this anomaly in late May.  Barron’s reported it the following weekend.  That may or may not have been the catalyst to kick-start the move, but since June 1st the EEM is up 16.4% vs. 5.3% for the SPY.  On Monday, the EEM broke out.

I have been trading BRIC (Brazil, Russia, India and China) related stocks, a subset of the EEM, for 5 or 6 years.  Over the past year or so I have focused primarily on Brazil for a myriad of reasons.  However, the awarding of the 2016 Olympics to Brazil confirmed my rationale.  The number of jobs created to build the infrastructure to support the Olympics will be unprecedented.  Additionally Brazil’s Petrobras, one of the world’s largest integrated oil companies, has discovered literally billions of barrels of oil off the coast in the last two years.  The company will soon kick-off a $224B development effort.

The number of well paying jobs created from these projects will elevate millions of people into the middle class.  This newfound wealth will find its way into circulation quickly, because Brazilians love to spend.  As Illan Goldfajn, chief economist at Brazilian bank Itau Unibanco Holding SA recently stated, “if the world is looking for savers, Brazil is not much good … But if it’s looking for consumers, then we might be able to help.” Companies that supply mobile phones, cars, homes and furnishing will all prosper.

There are several different ways to play Brazil.  The most straight forward is thru EWZ the Brazilian ETF.  EWZ broke out on Monday as well.

EWZ looks great until you look at it relative to BRF, the Brazilian Small Cap ETF.

BRF is a concentrated play on domestic investment themes such as home building and consumer goods.  It broke out in July and is currently making all-time highs.  EWZ has under-performed due to structural issues.  Petrobras, the largest component of EWZ, has lagged as it negotiated an agreement with the government for the rights to explore and develop the newly discovered oil fields.  Shareholders were concerned that the company would have to overpay for the rights.  An agreement to pay the government $42.5B was reached last week.  This should remove some friction that was inhibiting EWZ.

Gafisa (GFA) a homebuilder, one of the largest components in BRF, is another way to pay Brazil if your preference is individual stocks.

Although my focus has been Brazil, its neighbor Chile (ECH) has been on fire.

Focus or not, I would have bought ECH if it had been on my radar.  I am not up to speed on the catalyst in Chile, but according to Jack Dzierwa, co-manager of the Global Emerging Markets Funds, economic stability and increased investment in the domestic sector pushed Chilean markets to all-time highs this summer.  He has an excellent video presentation on the ABCs of Latin America – Argentina, Brazil and Chile.

Speaking of Argentina, Jack wasn’t very high on the country, but Mercadolibre (MELI) is based there.  Dubbed the “Latin American eBay,” the Buenos Aires company runs the region’s largest online shopping center. It operates its online store in 12 Latin American markets: Argentina, Brazil, Colombia, Costa Rica, Chile, Ecuador, Mexico, Panama, Peru, the Dominican Republic, Uruguay and Venezuela.  Brazil generated more than half of its revenue last year.  MELI dovetails very nicely into my rising middle class theme.

I spend a great deal of time on Stock Twits – a community of well over 100,000 traders.  I believe a certain amount of sentiment can be ascertained by participating regularly.  If my instincts are correct Latin American stocks and more broadly Emerging Market stocks are underloved.  If that’s true this party is just getting started.

Several years ago I read Goldman Sachs’ research paper on the economic potential of the BRICs (Brazil, Russia, India and China).  Since then I have devised different investment strategies to capitalize on this trend. Search my archives for numerous posts on this topic. Recently two additional catalyst have caused me to shift my focus primarily to Brazil – 2014 World Cup and 2016 Olympics.  With the World Cup kicking off this weekend its a good time to look at how this year’s host, South Africa, has benefited from the games.

The following is from Frank Holmes Weekly Investor’s Alert:

• World Cup will generate 400,000 jobs and contribute $7.3 billion to the country’s GDP
• 450,000 tourists will visit the country spending a total of $1.1 billion
• $2.2 billion was spent on 10 stadiums that will host the matches
• $9.1 billion was invested in road systems, $2.4 billion in airports and $2 billion on a new commuter rail

That’s all fine and dandy, but how can investors benefit from this goodness?  Let’s take a look at South Africa’s stock market performance.

Notes:

• EZA is an ETF of publicly traded securities in the South African equity market
• 252 is average number of trading days in a year

Nothing too exciting.  EZA tracked the S&P 500 over the past year.  It gets a little more interesting with a larger look back period.

EZA outperforms a little over 15% over a two year period.  Finally, since it is 4 years before the Brazilian World Cup let’s extend the look back period to 4 years.

A 30% out performance over 4 years ain’t bad.  I expect more is possible in Brazil with the Olympics following 2 years after the World Cup.  The Brazilian Small Cap ETF (BRF) and VALE, one of the world’s largest miners, remain my favorite ways to play Brazil ( tweets, tweets, tweets).

BRF is recovering from a pounding in May.  Now may be a good time to place a few chips on Brazil in your long term accounts.  I plan on throwing a few bucks its way every time it approaches the 200 DMA.