Brazilian stocks and exchange traded funds, most notably the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ), have been among the worst-performing emerging markets assets for over a year, but there could be technical reasons to consider EWZ’s small-cap counterpart, the Market Vectors Brazil Small-Cap ETF (NYSEArca: BRF).
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.
“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.
The good news for BRF is that the ETF is not excessively allocated to the energy, financial services and materials sectors. Those groups combine for just over 23% of BRF’s weight. Rather, BRF is more of a play on a potential rebound by the Brazilian consumer as consumer staples and consumer discretionary names combine for nearly 41% of the ETF’s weight.
BRF’s “long-term trend is clearly in the downward direction, as illustrated by the dotted trendline. While at first glance, this chart is extremely bearish, it is worth noting that the oversold readings on the Relative Strength Index and the fast Stochastic indicator, shown by the blue circles, are suggesting that a short-term bounce could be in the cards. While it may not seem like much on the chart, a move to the trendline represents an increase of nearly 14% from current levels,” according to Investopedia.
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.
Market Vectors Brazil Small-Cap ETF
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.