Up 54.3% year-to-date, the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ), the largest exchange traded fund tracking Brazilian equities, is one of 2016’s best-performing single-country emerging markets ETFs.
However, some of the wind has come out of EWZ’s sails in recent weeks. EWZ slid almost 4.2% last week and over the past month, the ETF is lower by 11.6%, a decline that has taken the fund below its 20- and 50-day moving averages.
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Earlier this year, EWZ surged on optimism that President Dilma Rousseff will finally be removed from office and that a new administration may steer the economy toward growth. Brazilian markets strengthened on hopes that acting President Michel Temer, who will remain as the country’s leader if the Senate decides to impeach Rousseff, will be to renew economic growth and damp corruption that has long plagued the Brazilian economy.
However, there are other pressing issues for Brazilian stocks, including ongoing concerns about the country’s banks. That issue is particularly relevant for EWZ because the ETF allocates 36% of its weight to financial services stocks, more than double its second-largest sector weight, consumer staples.
“Fitch maintains a negative rating and sector outlook on the Brazilian banking industry. The overall asset quality has deteriorated and, although still manageable, the still harsh environment may limit the increase of credit into the system both by the concession and demand side,” said Fitch Ratings in a note posted by Dimitra DeFotis of Barron’s.
SEE MORE: Brazil ETFs Strengthen on Realistic Government Guidance
Brazilian stocks have rallied this year and banks in Latin America’s largest economy appear inexpensive, those institutions are faced with declining consumer credit quality. Additionally, some Brazilian states have recently delayed payment to public workers, potentially crimping the ability of those workers to repay loans taken from Brazilian banks.
“Despite a slight improvement in investor and consumer confidence in the last months, the operational environment remains challenging and banks, especially the public ones, may need to constitute some additional provisions for bad loans in 2017, which can also limit profitability during 2017,” according to the Fitch note posted by Barron’s.
Brazil’s central bank has lowered the benchmark selic rate twice in recent months.
For more information on the Brazilian markets, visit our Brazil category.