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Portfolio Need Some Spice? Brazil's Market Is Red Hot

Kenneth Stier|Features Writer
Monday, 28 Apr 2008 | 11:32 AM ET

The long-standing joke about Brazil is that it's the country of the future--and always will be.

Brazil, Brazil Flag
CNBC.com
Brazil, Brazil Flag

But in the current worldwide boom in commodities--especially oil--Brazil’s time in the sun may have finally arrived. And that's good news for investors hungry for better yields than what they may be getting at home.

“The long-term outlook in Brazil is extremely good, no question about that as far as we are concerned,” says Geoffrey Dennis, Latin American equities strategist for Citigroup Global Markets .

Thanks to the recent discovery of a mega oil field, the country’s oil reserves may soar to 53 billion barrels, up from 12 billion. That would catapult Brazil virtually overnight into the ranks of major oil producers, just behind Venezuela and Russia.

Analysts say Brazil’s strong growth prospects are also buttressed by solid domestic demand, supported by sound macroeconomic fundamentals and a new financial stability that is allowing millions to take out mortgages and buy cars for the first time.

It’s a “classic story” of a rapidly maturing economy, now poised for a secular bull market that looks to Michael Hartnett, global emerging markets equity strategist with Merrill Lynch, much the US market in the mid-1980s.

Investors looking to get a piece of the action can buy US exchange-traded American Depositary Receipts, or ADRs, for some Brazilian blue-chips, such as the Petrobras, the state oil firm, or Vale , the world’s third largest mining firm.

Country-Specific ETFs

For a broader, more diversified play there are also exchange-traded funds, or ETFs, such as the country-specific iShares MSCI Brazil Index as well as an expanding universe of mutual funds with Brazilian exposure.

Morningstar's director of exchange traded securities, Jeffrey Ptak, said there are probably several hundred mutual funds with more than 10 percent Brazilian exposure. He recommended T. Rowe Price Latin America, with 66 percent of assets in Brazil, a fund reporting tax-adjusted returns of 48 percent in the last three years.

Investors should also be poised for expanded commodity-based plays, particularly as the Sao Paulo exchange (BOVESPA) proceeds to merge with Brazilian Mercantile and Futures Exchange(BM&F), which would form one of the largest exchanges in the world.

Brazil's President Luiz Inacio Lula da Silva.
Andre Penner
Brazil's President Luiz Inacio Lula da Silva.

Brazil recently pulled ahead of China and Korea, for the time time, as the largest emerging market in the world, and currently constitutes 14.95 percent of the MSCI GEMS.

By market capitalization, Brazil now ranks 10th in the world, recently jumping ahead of Italy and the Netherlands.

US Federal Reserve rate cuts provided an inadvertent boon to Brazil, which is a world player in a range of mostly dollar-denominated commodities from soy, coffee, iron ore, steel, orange juice, and sugar, the basis for Brazil’s status as an ethanol champion.

High commodities prices have spurred growth--expected to be roughly 4.5 percent this year--but they have also stoked inflationary pressures which some see as key potential dark cloud.

Year on year inflation has recently run at 4.5 percent; that nudged up to 6 percent during the last six months, which prompted the hawkish local central bank to raise interest rates by 50 basis points recently, the first rise in three years.

Inflation a Concern

“Our concern would be that those inflation numbers could deteriorated considerably further in the short-term, forcing the Central Bank to put rates up more than the market anticipates,” cautions Dennis. “Our forecast is that rates go up 175 basis points.”

That would put a crimp in the local banking sector but some say that wouod be a good time for investors to take a look.

“Should banking stocks take a hit from this we think this would be an attractive entry point for investors going forward,” said Mark Schaltuper, a Brazilian analyst with Business Monitor International (BMI), a London-based research firm specializing in emerging markets. “We believe that banking sector’s fundamentals …will probably weather the storm a bit better" than US or even Europeans banks.

Interest rates hikes is one of the four potential “game-changing events for the Brazilian equities market,” adds Hartnett; others are a dollar rally, the Fed halts its cuts, or if the Chinese economy slows.

Brazil play is really two markets--one that export-sensitive, dominated by commodities, and the domestic market and a key question facing investors is when commodities will cool off, triggering an equities correction. Analysts expect this in the second quarter or the second half.

“If you are long-term investor, I think sooner rather than later I would start the rotation out of the Brazilian commodity plays and into the Brazilian credit plays--but slowly--I don’ think you need to be dramatic about it,” says Hartnett.

Brazilian equities are up a hefty 46 percent since last August. That led Citi, in a late February note, to say Brazil was “overbought, expensive and overdue a pause” but Dennis now says this was to sound a cautionary note in line with bearish global equity markets.

Latin American equities have outperformed other emerging markets but the region was still “hostage to global fortune,” he said.

For ETFs Mexico bested Brazil this year but “the story going forward here still over the medium-term still favors Brazil,” insists Hartnett.

Another area of interest for investors are Brazil’s expanding commodity plays, inlcuding the new synergies offered by the merger of BOVESPA and BM&F.

“The BMF itself is really looking into ways to attract foreign investors as well [and] as this liquidity increases there is going to be more scope for foreign investors to get involved in our view.”said BMI emerging market analyst Rahul Ghosh, who noted that the value of agricultural futures contracts there rose 94.4 percent last year.

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