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EWZ – November Review: The Political Crisis Deepens

Summary Share price of the iShares MSCI Brazil Capped ETF declined by 1.53% in November. The development was driven mainly by the political factors. The economic situation of Brazil is worsening, the political crisis is deepening and the financial markets would welcome the fall of president Rousseff. The iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) lost 1.53% of its value in November. Although it was up by more than 11% at one point, it lost all of its gains during the last days of the month, as the political crisis deepened and investors started to fear that the government will be unable to enforce the needed economic reforms and budget cuts. The economy is still in a bad shape, the latest data show that it declined by 4.5% y-o-y in Q3, which is worse than expected. The unemployment rate is at 7.9% and growing and inflation is in the double digit area. Shares of the beverages producer Ambev (NYSE: ABEV ) are still the biggest holding in EWZ’s portfolio, with weight of 10.61%. Ambev is closely followed by preferred shares of Itau Unibanco (NYSE: ITUB ) (10.24%). Besides Ambev and Itau Unibanco, only preferred shares of another bank, Banco Bradesco (NYSE: BBD ), have weight over 5%. The 10 biggest holdings represent 61.47% of the portfolio, which is slightly less, compared to 62.22% in October. Generally, no significant changes in the structure of EWZ could be observed in November. Only common shares of Vale (NYSE: VALE )are not among the TOP 15 holdings anymore, as their value declined sharply after the disastrous dam collapse . Source: own processing, using data of iShares.com Out of the 15 biggest EWZ holdings, the biggest gains were recorded by Fibria Celulose (NYSE: FBR ) in November. The credit rating of the pulp and wood producer has improved, it has completed the financial package for its Horizonte 2 project and it declared a dividend that will bring to its shareholders dividend yield over 7%. Shares of the company grew by 8.72% in November. Shares of the Brazilian airplane producer Embraer (NYSE: EBR ) jumped by 7.5%. For Embraer, November was the third consecutive month of very big gains. On the other hand, November was very negative for Vale. After the dam collapse, shares of the miner declined strongly. Preferred shares of Vale lost almost 25% of their value. (click to enlarge) Source: own processing, using data of Bloomberg The traditionally high correlation between EWZ and Petrobras (NYSE: PBR ) share price was disturbed during the first two weeks of November, although it increased back to its normal levels in the end of the month, after the corruption scandal became one of the main topics of discussion again. Also, the correlation between EWZ and oil prices (represented by the United States Oil ETF (NYSEARCA: USO )) and between EWZ and S&P 500 was relatively low or even negative during the better part of the month. One could say that the Brazilian share market lived its own live and the share price development was driven by the political situation in the country and by the efforts to enforce the austerity measures. (click to enlarge) Source: own processing, using data of Yahoo Finance November was a relatively calm month for EWZ. Although the EWZ share price was up by 11% only a couple of days before the end of the month, but eventually ended the month with a 1.5% loss, the overall volatility measured by the 10-day moving coefficient of variation was lower compared to most of the 2015. It moved in the 1%-3% range for the better part of November, however it broke out of this range in the last days of the month. Given the early December developments, December will be probably more volatile compared to November. (click to enlarge) Source: own processing, using data of Yahoo Finance Some of the more interesting news: Fibria announced that the estimated capex for the Horizonte 2 Project has been revised from $2.5 billion to $2.2 billion. The expenditures will be funded by a combination of its own cash, Agribusiness Receivables Certificates and credit facilities, the estimated average borrowing cost is only 2% p.a. The company also announced that Moody’s has improved its credit rating from Ba1/Positive to Baa3/Stable. Fibria will pay a dividend of approximately $0.96 per shares, which means a dividend yield of over 7.2%. On November 5, a disaster occurred in southern Brazil. A tailings dam owned by iron miner Samarco collapsed and more than 60 million cubic meters of toxic mud destroyed the town of Bento Rodrigues and contaminated the Rio Doce river. Samarco is a 50:50 joint venture of Vale and BHP Billiton (NYSE: BHP ) and the disaster had a significant impact on share prices of both companies. According to the latest news, Brazil sued Samarco for $5.3 billion over the spill. Cemig (NYSE: CIG ) won generation concessions for 18 hydro plants with total installed generation capacity of 699.57 MW. The new concessions should partially offset the probable loss of the Jaguara and Sao Simao concessions with total installed capacity of 2,134 MW. Companhia Siderurgica Nacional (NYSE: SID ) together with an Asian consortium consisting of ITOCHU Corporation ( OTCPK:ITOCY ), JFE Steel Corporation, POSCO (NYSE: PKX ), Kobe Steel ( OTCPK:KBSTY ), Nisshin Steel ( OTC:NSSSY ) and China Steel Corp. ( OTC:CISEY ) combined some of their assets into a new company Congonhas Mineiros. The new company will consist of an iron ore mine, railroad and port and it will be 87.52% owned by CSN and 12.48% owned by the Asian consortium. A prominent member of the ruling Workers’ Party, senator Delcidio do Amaral, was arrested due to his participation in the Petrobras related corruption. Amaral is a close collaborator of president Rousseff. His arrest further supported the voices calling for Rousseff’s impeachment. Conclusion As the early days of December showed, the Brazilian share market is still strongly affected by the Petrobras corruption scandal and the related political crisis. On December 2, the impeachment proceedings against president Rousseff opened in the lower house of Congress. As a result, the EWZ share price jumped by almost 6% in two days. The financial markets welcomed the vision of a government change and if further developments indicate that Brazil will be able to get rid of Rousseff, EWZ will grow further.

Don’t Be An Investment Hero: Avoid The Temptation Of That Brazilian ETF

MSCI Brazil is down 75% in USD since 2008 which could spark some intrigue for contrarian investors. However, the equity market is still 300% higher than 2003. Given the poor economic picture, valuation levels that aren’t a screaming buy, optimistic analyst expectations for the future, and a very negative technical set-up, investors should be looking elsewhere. For the contrarian investor out there, it is always tempting to invest in downtrodden markets. Many times buying into an equity market that has been out of favor can be a profitability investment strategy. However, this type of strategy takes a lot of patience and time because picking the bottom in any market is extremely difficult. Cheap stocks can always get cheaper. A stock market that is off 75% from a recent high may seem like a screaming buy. But is it actually a screaming buy if that same market is still, amazingly, up over 300% over the past 13 years? Aren’t there plausible scenarios where this market could halve from current levels but that would still mean it is 200% higher over the past 13 years? This is the quandary facing investors who want Brazilian exposure. In USD terms, MSCI Brazil is now back to levels last seen in 2005. However, as we stated above, it is still 300% higher than the 2002 low even as it is 75% off the 2008 high. So is now an interesting time to invest in Brazil? While it feels like it can’t get worse, we believe investors shouldn’t try to be a hero in this market. (click to enlarge) The Brazilian economy is in shambles. Exports are in a free fall down 24% year-over-year. Industrial production is declining at the fastest year-over-year rate since 2009 and has had a negative year-over-year growth rate for 16 months. The unemployment rate has spiked to a five-year high while retail sales are declining at a pace last seen in 2003. Finally, even with excess capacity in the economy increasing and consumption slowing, Brazil is combating inflation as the CPI increased at 9.5% year-over-year rate in August. With this type of economic back drop its fairly easy to understand the pressure that Brazilian stocks have been under. What is harder to understand is how valuations have stayed so high. (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) No matter which valuation level you look at, Brazil still isn’t cheap. The median price to cash flow level for the MSCI Brazil Index is still 8.58x. This is nearly 3x the trough level during the financial crisis. The median price to earnings ratio has fallen much more than price to cash flow, but it to remains well above 2008 lows. It currently stands at 13.84x which is only slightly below the average level since 2007. Where valuations are starting to look intriguing at least is when we look at median price to sales and median price to book ratios. The median prices to sales has dropped to just 1.11x which is the lowest level since 2009. The median price to book is at 1.59x which is on the low end of the last couple of years but still higher than in 2012 and 2008-2009. Overall, valuation levels still aren’t at levels to make it worthwhile for investors to take the plunge. (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) Given the economic backdrop, the outlook for Brazilian stocks remains surprisingly optimistic as analysts’ earnings expectations still seem out of step with the current situation. Over the past decade, Brazilian stocks have increased EPS by 12% annually. Currently, consensus EPS estimates for this year are very negative at -25.8%. However, analysts expect Brazil to be able to make up for this growth in the following three years by averaging a robust 20.3% growth rate from FY2-FY4. This seems like an incredibly high hurdle for Brazil to leap over even as these growth expectations start from a depressed level after this year. Finally, from a relative technical perspective the iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) remains firmly in a down trend relative to the MSCI All-Country Index. This ETF looks like it is years away from forming a base relative to the global equity market let a lone beginning to outperform. It recently broke down to a new four-year relative low. All in all, given the poor economic picture, valuation levels that aren’t a screaming buy, optimistic analyst expectations for the future, and a very negative technical set-up, investors should be better off allocating their scarce investment capital to more productive equity markets around the globe. The original posting of this article can be found here . All data was created by the author and sourced from Gavekal Capital, MSCI and FactSet. 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. I have no business relationship with any company whose stock is mentioned in this article.

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.