The iShares MSCI Brazil Capped ETF (NYSEArca: EWZ), the largest exchange traded fund tracking Brazilian equities, traded slightly higher Monday and is up more than 16% year-to-date even after a ratings agency lowered its rating on Brazil’s sovereign debt.
Brazil is undergoing massive reforms, including a 20-year constitutional spending cap tied to inflation, which has helped bring the economy out of a deep recession and strengthened investment confidence. The country now is working on passing pension reforms. Meanwhile, the Brazilian market is enjoying an acceleration in earnings growth.
“Brazil’s downgrade reflects its persistent and large fiscal deficits, a high and growing government debt burden and the failure to legislate reforms that would improve the structural performance of public finances,” said Fitch Ratings. “The decision of the government not to put the social security reform to a congressional vote represents an important setback in the reform agenda that undermines confidence in the medium-term trajectory of public finances and the political commitment to address the issue.”
Last week, Fitch lowered Brazil’s Long-Term Foreign Currency Issuer Default Rating (IDR) to ‘BB-‘ from ‘BB’ while revising its outlook on the country’s rating to negative from stable.
Political risks, of which Brazil is no stranger to, linger for the giant Latin American economy.
“The October Presidential and Congressional elections mean that the social security reform will be delayed until after the elections and there is uncertainty whether the next administration will be able to secure its approval in a timely manner,” according to Fitch. “Brazil’s fiscal deficits remain large and are expected to decline only gradually. The government over-performed its primary deficit target for 2017. However, the general government deficit reached over 8% of GDP in 2017 (compared with 3% for the ‘BB’ median), and Fitch forecasts the deficit to average just over 7% of GDP during 2018-2019.”
Brazil, Latin America’s largest economy, is a major producer of an array of commodities, including iron ore, oil and sugar, meaning a weak dollar benefits Brazilian commodities producers. That much is evident as the real has surged against the greenback since early 2017. Additionally, Brazil’s central bank actively reduced borrowing costs last year and is expected to continue doing so in 2018. Plus, Brazilian stocks appear cheap relative to global benchmarks.
Traders who are betting on a quick turnaround could look to the two times leveraged ProShares Ultra MSCI Brazil (NYSEArca: UBR) or the three times leveraged Direxion Daily Brazil Bull 3x Shares (NYSEArca: BRZU). On Wednesday, BRZU was the best-performing US-listed ETF on an intraday basis.
For more information on the Brazilian markets, visit our Brazil category.