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EWZ: August Review

Summary EWZ share price declined by more than 13% in August. The decline was caused by weak commodity prices, uncertainty on global financial markets and Brazilian political instability. Brazilian GDP declined by 1.9% in Q2 2015, unemployment rate is at 7.5% and inflation rate attacks the 10% level. It is hard to expect any major recovery of EWZ share price anytime soon. Share price of the iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) kept on falling in August. Its value declined by 13.3%. The Brazilian share market has been hardly hit not only by the problems of Chinese economy but also by its own economic problems, weak commodity prices and continuing Petrobras corruption scandal. On August 11, Moody’s downgraded credit rating of Brazil from Baa2 to Baa3, with outlook negative. Another downgrade will push Brazilian bonds to the junk territory. The data published in late August showed that Brazilian GDP declined by 1.9% in Q2. It is the biggest decline since 2009. The unemployment rate increased to 7.5% and inflation rate hit a new 12-year high at 9.56%. The bad economic situation and still growing corruption scandal led to a series of demonstrations against president Rousseff. The 15 biggest holdings represent 62.2% of EWZ’s portfolio. The biggest weight have shares of Ambev (NYSE: ABEV ) that represent 10.35% of the portfolio. Slightly lower weight have preferred shares of Itau Unibanco (NYSE: ITUB ). There are preferred shares of 5 different companies (Itau Unibanco, Banco Bradesco (NYSE: BBD ), Petrobras (NYSE: PBR ), Vale (NYSE: VALE ), Itausa-Invetimentos ( OTC:IVISF )) among the TOP 15 holdings. Their cumulative weight is more than 25%. Source: Own processing, using data of iShares.com EWZ shares lost more than 13% of their value and only share price of BMF Bovespa and Vale increased slightly in August. On the other hand preferred shares of Banco Bradesco and Itausa Investimentos declined by 15.51% and 13.33% respectively. Shares of other companies from the financial sector were hit hard as well. The economy is in a bad shape. Brazil has a negative GDP growth as well as high inflation rate and the fiscal and monetary policies can’t tackle both of the problems at once. And downgrade of Brazilian credit rating weighed on the financial sector as well. (click to enlarge) Source: Own processing, using data of Bloomberg EWZ was strongly correlated with oil prices represented by the United States Oil ETF (NYSEARCA: USO ), however this correlation declined notably during the last week of August, as oil price bounced hard off its bottom while EWZ kept on declining. On the other hand EWZ still maintains very high positive correlation with Petrobras share price. (click to enlarge) Source: Own processing, using data of Yahoo! Finance EWZ was highly volatile in August. But it is important to note that given the wild ride experienced during the first seven months of 2015, August was relatively calm for EWZ, despite the turbulent developments on global financial markets. It is hard to expect that the Brazilian share market’s volatility will start to calm down and stabilize anytime soon. (click to enlarge) Source: Own processing, using data of Yahoo! Finance Some of the more interesting news: The Brazilian government approved an austerity measure that should help to balance the government budget and save Brazilian investment grade credit rating. The measure will lead to higher corporate taxes which should increase tax revenues by $2.9 billion. A prosecutor at Brazilian Federal Account Court said that Rousseff broke the fiscal responsibility law. The government was systematically delaying debt repayments to Brazilian state controlled lenders in order to make the fiscal account look better. The money were used for various social programs. It is said that repayments worth $11.6 billion were delayed in 2012 and 2013 alone. According to the Brazilian constitution, president who violates the fiscal responsibility law should be impeached and removed. It is estimated that Petrobras may need to pay more than $1.6 billion to settle the investigations related to the corruption scandal that are held in the USA. But Petrobras denied any ongoing negotiations regarding an eventual payment of a fine. Itau Unibanco announced that between August 5 and August 26, it acquired 30,380,000 of its own preferred shares. According to the share buyback plan approved on July 30, the company is authorized to acquire 11 million of its common and 55 million of its preferred shares, during the time period from August 5, 2015 to August 4, 2016. Conclusion Brazil is in huge trouble. The economy is weak, GDP is declining, inflation and unemployment rates are growing. Not only energies and metals but also agricultural commodity prices are weak. The Petrobras corruption scandal hasn’t been fully resolved yet and there is another scandal, as president Rousseff used some creative accounting to make public finances look better before the last year’s presidential elections. Adding to it the uncertainty on the global financial markets that are afraid of the slowing Chinese economy and the potential U.S. interest rate hike, it is hard to expect any meaningful recovery of EWZ share price anytime soon. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Is It Safe To Return To Emerging Market Investments?

Emerging market investments across asset classes have suffered a brutal combination of collapsing commodity prices and a strong US dollar this year. Is the bottom near, and where might investors look for bright spots? 2015 has been a lackluster year for US and European markets, but their performance is still leagues better than what emerging market investors have struggled through. The MSCI Emerging Markets Index is down over 17% year to date, and emerging market bonds are down nearly 2% so far in 2015. Most tellingly, emerging market currencies have been the worst hit, down more than 20% over the last twelve months, which has in part fueled the collapse of other emerging market asset classes. Brazil’s real, for instance, is down 30% year to date. (click to enlarge) Source: Bloomberg and Global Risk Insights The causes for the destructive trend are not difficult to spot: commodities (led by oil) have fallen to multi-year lows, investors have hit the panic button on Chinese growth, and the US Federal Reserve has signaled an impending rate hike. As if that tally of obstacles was not enough, two of the major attractions to emerging market investments have been diminished as of late: high growth and low correlation with developed markets. The euphoria-fueled growth rates of emerging markets, especially those of the BRICS countries, are gone. The optimism of investors flooding into these markets for newly middle class consumers and market-oriented structural reforms may have instead been a thin veneer over high commodity prices piqued by Chinese infrastructure spending. (click to enlarge) Source: Bloomberg and Global Risk Insights While this growth was seen as a secular trend that could act as a hedge against the cyclicality of developed markets – particularly surrounding the financial crisis – the focus on zero-interest rate policies and quantitative easing by the US Federal Reserve, Bank of England, and European Central Bank have brought investment cycles of developed and emerging markets in line with one another. 2013 and 2014’s taper tantrums are the most memorable examples of this: investors walking back down the risk ladder in anticipation of Fed tightening are moving away from emerging markets as well as developed market equities. When the sell-off slows, emerging markets will once again be an attractive opportunity The trends that have led to the emerging market sell-off are not permanent, and when these dark clouds lift, more investors will see promising returns. More importantly, some regions have been unfairly maligned during the sell-off. So is the time right for investors looking to diversify, and if so, where do they turn? Of course, consistently timing the market’s peaks and troughs is a fool’s errand , but there is one date on the horizon that will keep capital flows in emerging markets in a tenuous place: the Fed’s first rate hike . Once that has passed, especially given the Fed’s guidance that the rate hike cycle will be slow and designed to sustain financial market stability as much as possible, the brighter markets that have been unfairly grouped with less promising markets should begin to shine again. There are some reasons to believe the future is looking brighter across emerging market regions and asset classes. Currency market observers are beginning to believe that some emerging market currencies are becoming fairly valued again, after being overvalued throughout most of the QE era. Those that are still unattractive are those with enough dependence on China to spook investors. As momentum falls away from these trades, earnings and yields (in dollar-terms) will stabilize. Speaking of yields, the transition to local currency denominated debt in emerging markets has cleared up much of the uncertainty that fueled the 1997 Asian financial crisis: unwise pegs to the US dollar and dollar-denominated debt. Even as investors dump emerging market debt as yields fall due to recent currency movement, the likelihood of default is lower than it historically has been . “Two dreaded Cs” The headwinds of China and commodity prices remain a major point of differentiation across regions. Regions with low exposure to those two dreaded Cs will look like fundamentally better investments, at least until uncertainty over those areas persist. If the world is witnessing a secular shift in Chinese growth, that could be a period of several years. The trade linkages of emerging market economies is more important than ever in this context. Of the several emerging markets that are net commodity importers with low exposure to China, a few are notable: India and Poland. Indian GDP grew 7% last quarter (albeit partly because of a change in methodology that brings it in line with international norms), placing the country in a unique place with international investors: after Prime Minister Modi failed to live up to the unrealistic expectations for reform that were created during the early days after his election, it lost its place as an emerging market darling. However, in the current emerging market paradigm, India will continue to benefit from low commodity prices and has an economy that is largely based on domestic goods and services, insulating its business sectors from international uncertainty. While the other namesakes of the BRICS group crumble, each for its own idiosyncratic reason, India looks to be the only one on the upswing. Poland exhibits similarly low exposure to the dreaded Cs. It sits in a unique trade situation as a major manufacturer for the EU market , especially of automobiles, and an increasingly important member of the EU. Even as Europe has struggled to find growth, Poland has not. Now that the industrial and consumer spending prospects for most of Europe look their best since 2008, Poland stands to benefit. Underlining that potential is Poland’s strong democratic system and its low exposure to China. While volatility and indiscriminate fear across emerging market asset classes are still high in light of global macro trends, especially the Fed’s rate hike, there is an opportunity to differentiate between markets that will continue to fall victim to these trends, and those that will not. The wholesale euphoria of the last decade’s emerging market investments does not look to be on its way back soon, but the push towards higher growth and market-enhancing reforms still marches on for several key actors.

FSCLX – A Fund That Would Be Appreciated By Growth-Oriented Investors

Summary Is this a good time to invest in a growth-oriented fund? What are some risks in the current financial environment? What is the future outlook for U.S. corporations? Investors come in different categories. Some are willing to take high risk and hope to get high returns – these investors would gravitate towards hedge funds, short selling, and high yield junk bonds. There are some others who are risk averse and their primary goal is the preservation of capital. For these investors, the natural choice would be bank CDs, bonds with AAA ratings and money market funds. The Fidelity Spartan Mid Cap Index Fund Investor Class (MUTF: FSCLX ) offered by Fidelity would be ideally suited for growth-oriented investors who are willing to assume a higher level of risk for higher returns. FSCLX replicates the Russell Midcap Index which measures the performance of the mid-cap segment of the U.S. equity market. The fund provides investors with a broad diversification to the mid-cap sector of the U.S. equity market. Typically, mid-cap companies outperform large cap stocks and experience a higher level of revenue and earnings growth rate. These companies have transitioned from being small-capitalization firms to becoming medium caps with an average market capitalization of $12 billion and the highest being $29 billion. They have proven themselves with established products, seasoned management and a track record of increasing revenues and profits. As these mid-cap companies continue to gain market share in the U.S. and globally, they are more likely to generate higher returns to investors than large companies with saturated markets. According to the Fidelity Chart, an investment of $10,000 in FSCLX in September 2011 would be worth $19,110 during July 2015. This represents a return of 17.5% during approximately a time frame of four years. The following are some key statistics for FSCLX NAV Gross Exp Ratio Turnover Net Assets 52-week High/Low $16.43 .33 8% $ 1.4 B $ $15.79 – $18.40 This fund was created during 2011 and the performance measures are as follows for FSCLX and the Russell Midcap fund: (click to enlarge) Data Source: Fidelity Data Source: Russell.com FSCLX – Sector Diversification: (click to enlarge) Data Source: Fidelity Risk Measures: The standard deviation which measures the variability of returns is 10.08% for this fund. The companies within the fund face myriad risks such as increased competition, operating and financial leverage, regulatory/political risk, strikes, lawsuits, etc. Most of the company specific risks would be diversified away since the fund is well diversified in 10 sectors with a total of 831 holdings. The losses sustained by some companies would be offset by the strong financial performance of other companies within the fund. However, the market risk is high and the fund will react unfavorably to any news regarding U.S./global economic slowdown, inflation, oil prices, currency risk, interest rates, etc., with possibly double digit declines in the Net Asset Value (NAV) of the fund. The Sharpe ratio is 1.94 which indicates the fund is able to generate higher returns relative to the risk. Impact of Chinese economic slowdown: The stock market has been very volatile during the last few weeks, with the share prices of stocks and most of the funds and ETFs going down significantly. This deep loss in investments has been primarily attributed to the Chinese economic slowdown. The biggest fear is that this slowdown might adversely impact the U.S. economy which will have a domino effect on U.S. corporate profits. Some interesting excerpts on this subject from Ben Stein, a CBS contributor: “August is the cruelest month. A good chunk of my savings disappeared as the stock market convulsed, and we’re down at some points by well over 10 percent. Why did it happen? The pundits and analysts appeared and said it was because of the Chinese devaluation and possible serious weakness in China. This, in turn, would devastate U.S. exports, supposedly, to China and sink the ship of our prosperity.That was, and is, nonsense. The U.S. economy’s output is roughly $18.4 trillion per year. Total exports to China are very roughly $120 billion per year. That’s a lot of hamburgers, but it’s roughly seven-tenths of one percent of the U.S. economy. If our exports to China fell by 20 percent – a large number – that would have only trifling effect on the U.S. economy – very roughly one-tenth of one percent of U.S. output, trivial even for an economy as big as ours”. Future Outlook: In summary, for the next few weeks the markets will continue to be volatile. The Federal Open Market Committee (FOMC) will have a meeting on September 16/17 to determine the direction of interest rates. The markets will be closely watching the Fed’s decision on interest rates as well as any new developments on the global economic front. The stock market will continue to experience wide fluctuations in share prices, NAVs of mutual funds and ETF prices in the near term. FSCLX will be more volatile as mid-cap funds have historically experienced greater variations in NAVs than large cap stocks. However, the good news is that the U.S. economy has been showing signs of strength, with an increase of 3.7% in the GDP growth rate in the most recent quarter, a booming housing market and a reduction in unemployment levels. It is hoped that all these factors will stabilize our financial markets which would perform well in the long run. FSCLX would be a good investment choice for investors who hold a well-diversified portfolio. The NAV is around $16 and is attractively priced and affordable for investors who would like to buy a round lot of 100 shares. The minimum investment is $2,500. The fund has low expense and turnover ratios. The Russell Midcap fund has a PE ratio of 21 and has sustained an average earnings per share (EPS) growth rate of 12% during the last five years. The dividend yield for the fund is around 1.64%. It is well diversified in 10 sectors with more exposure to the financial sector which constitutes 21% of total holdings. The future outlook for U.S. financial companies and non-financial corporations looks promising. According to a recent report by the U.S. Department of Commerce on U.S. Corporate profits: ” Profits from current production increased $47.5 billion in the second quarter of 2015, in contrast to a decrease of $123.0 billion in the first. Profits of domestic Financial Corporations increased $33.9 billion in the second quarter of 2015, in contrast to a decrease of $23.4 billion in the first. Profits of domestic Non-Financial Corporations increased $16.5 billion this quarter, in contrast to a decrease of $70.5 billion last quarter”. On a final note, it takes a lot of courage to invest in the stock market during turbulent times, especially high-risk, growth-oriented funds like FSCLX when everyone is selling and markets are continuously going down. FSCLX is trading at 11% below its all-time high and this could possibly be a buying opportunity for investors who felt disappointed they missed the boat when markets were at trading at the peak at the beginning of this year. As the U.S. economy continues to show signs of strength, this fund will likely provide higher rewards to investors who can tolerate price fluctuations and have the forbearance to hold on to the investment for a longer time frame. Disclosure: I am/we are long FSCLX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Disclaimer: The article represents the opinion of the author and does not constitute investment advice to buy or sell. Check with your financial advisor before you buy or sell funds.