BUY MSCI Brazil Index (EWZ)
Posted by intelledgement on Tue, 02 Jan 07
With all the talk of Venezuelan President Hugo Chavez’s crusades to discredit the USA in particular and capitalism in general, it is bracing to consider the case of Brazil. The largest country in South America both in terms of area and population, Brazil is enjoying healthy sustained growth of over 3% with manageable inflation, oil independence, political stability, a shrinking debt—in 2006, the government paid off $15.5B in IMF loans—and market reforms that have increased economic liberty. Exports are surging lead by material productivity gains in the agricultural sector; the country has run record trade surpluses in the past four years.
When he was first elected president in October 2002—over the vociferous opposition of the business community—Luiz Inacio Lula da Silva was generally expected to rollback the controversial market reforms of his predecessor, Fernando Cardosa. Instead, under Lula da Silva, the policies of tight money, inflation-fighting, and a floating real have continued, and both payroll and corporate taxes were cut. Increased growth—which had been running under 2% during Cardosa’s administration—ensued. Lula da Silva handily won re-election last October with 61% of the vote.
Brazil’s major challenge remains economic inequality. 31% of Brazilians remain below the poverty line—this compares to 25% in India, 12% in the USA and 10% in China—a condition that leads to social instability and crime, both of which are serious issues there. Therefore we need these goldilocks conditions to continue, and for them to produce a more even distribution of the larger pie for Brazil to remain a good long bet. Another risk factor is the debt level, which—even after the retirement of the IMF loans—remains high at 51% of GDP. Continued growth is needed to keep the debt reduction on track. There are some environmental concerns including pollution problems for most major cities and associated with mining activities; also international concern about Amazon rainforest defoliation is an issue with the potential to channel if not inhibit economic development. Finally, while in the fullness of time Brazil is a good hedge against USA economic decline, if there were a sharp USA downturn in the near future, it would hurt Brazil directly, as currently the USA is by far the largest importer of Brazilian goods and services (over 19% of the total).
In any event, Brazil’s market has been beating the pants off the USA of late:
Year Brazil USA
2006 33% 14%
2005 57% 6%
2004 37% 11%
2003 115% 29%
2002 -31% -23%
The instrument of our investment in Brazil is the iShares MSCI Brazil Index (EWZ). This exchange-traded fund is heavily weighted towards energy (28%) and mining (23%), as befits a fund for a rapidly developing country. There is also significant representation for finance (16%), consumer goods (6%), telecom (3%), and paper/forest products, transports, and aerospace/defense (2% each). The P/E ratio is running around 12 and the yield is 2%. EWZ is heavily traded (5.7MM shares/day).