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The iShares MSCI Brazil Capped ETF (NYSEArca: EWZ) has not been short of problems over the past couple of years. Many of the largest Brazil exchange traded fund’s woes are attributable to tumbling commodities prices, a weak real, alarmingly high interest rates, political corruption and a deepening recession.

Multiple factors are dragging on the Brazilian economy. Unemployment rose to 7.9% in September from 4.7% in October last year. Inflation has jumped over 10% for the first time since 2002. The budget deficit has widened to 9.5% of GDP. Additionally, lower commodity prices, diminishing consumer credit boom and a corruption scandal at state-run oil giant Petroleo Brasileiro have all weighed on the economy. [Corruption Probe Plagues Brazil ETF]

Now, banks in Latin America’s largest economy are facing corporate debt risks and that could be added to the list of problems facing EWZ.

“We reiterate our bearish view on Brazilian banks. While bank stocks have underperformed over the last 12-months and valuations are close to multi-decade lows (as we forecasted), we think it is still early to step in as the worse of the asset quality cycle is yet to come, earnings per share expectations and company guidance are too high, and macro fundamentals continue to deteriorate,” said Morgan Stanley in a note posted by Dimitra DeFotis of Barron’s.

Although energy and materials stocks have gotten most of the attention as being the drains on the Brazilian equity market, weakness in bank stocks cannot be overlooked. Vulnerable bank stocks are particularly problematic for EWZ because financial services are the ETF’s largest sector allocation, representing a third of the ETF’s overall weight.

In September, Standard & Poor’s downgraded Brazil’s sovereign credit rating to junk status, becoming the first major ratings agency to do so. Even after the retreat, Brazilian stocks may have further to fall as the economic contract worsens.

Against the backdrop of ongoing concerns, more aggressive traders may turn to a bearish or inverse ETF option to capitalize on continued weakness in Brazilian equities. For instance, the ProShares UltraShort MSCI Brazil Capped ETF (NYSEArca: BZQ) takes the -2x or two times inverse of the daily performance of the MSCI Brazil 25/50 Index, which acts as the underlying index for EWZ.

“Broadly, the corporate study found some scary stuff: The net debt to EBITDA ratio of 141 companies ws 3.4x, and 2.0 to 2.5x is comfortable/manageable. In five sectors — construction, oil & gas, transportation, basic materials and utilities — a combination of weaker debt ratios and greater exposure to the slowing economy implies greater debt-payback risk compared to other sectors, Morgan Stanley writes,” according to Barron’s.

iShares MSCI Brazil Capped ETF

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.