Banks are Problems for Brazil ETFs

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.