This week has brought more arrests in the escalating Lava Jato corruption scandal in Brazil, with a top aide to President Michel Temer among those hauled in for questioning.
Yet the iShares MSCI Brazil Capped exchange-traded fund (EWZ) rose 1.8% this week. What gives? It may be that demand for the ETF is increasing as investors with a shorting strategy borrow shares (a purchase now) to bet against the direction of Brazilian equities (a future sale at a lower price). EPFR Global today noted that in the seven-day period through May 24, Brazil funds saw net inflows:
“The flows into Brazil Equity Funds, most of which went to ETFs dedicated to this market, came on the heels of another twist in the country’s major corruption scandal which raised questions about the political survival of President Michel Temer and his ability to push through key reforms. The fact the money went largely to ETFs is consistent with investors rushing to establish short positions. But it is also true that investors have been conditioned in recent years to see any sell-off as a buying opportunity that will disappear quickly. Investors who bailed out of Russia Equity Funds the week Russia annexed the Crimea saw those funds post a collective gain of over 20% in the following three and a half months …”
Peter Donisanu, investment strategy analyst at Wells Fargo, wrote the following, date May 26:
“We believe that the sharp sell-off and continued weakness in Brazilian assets is reflective of the fragile underpinnings that had supported the recent stock, bond and currency rallies. We expect Brazilian equities, bonds and the real to face continued headwinds, given the reemergence of political uncertainties. … We would expect uncertainty related to the political environment to act as a headwind to business and consumer sentiment, likely weighing on economic growth and challenging investor theses of improving growth and reforms. As a result, we maintain our unfavorable equity rating on the Latin American region (of which Brazil is the largest member). Instead, our emerging-market equity guidance favors exposure to Asia—where improvements in trade and growth remain positive contributors to equity-market performance there. For Brazilian local-currency bonds, we expect yields to face to upward pressure stemming from political developments and potentially weaker-than-expected economic data releases … we expect the U.S. dollar to appreciate this year, putting downward pressure on the Brazilian real and likely leading the currency to 3.40 from 3.30 reais to the dollar …”
Ned Davis explains the conundrum for Brazil’s economy: good demographics, bad pension obligationss and now “slim chances” that pension reform will happen under President Temer. Economist Alejandra Grindal and Analyst Patrick Ayers write that Brazil’s demographics are quite attractive. But they note Brazil has an Illinois problem: benefits to the elderly are high, in line with the developed world, because pension payouts are structured to rise with cost-of-living adjustments:
“Despite the high levels of corruption, Brazil has a lot of things going for it. It remains the biggest economy in Latin America, with a large land and resource base. The workforce is becoming more educated, with almost half o fits population ages 25-64 attaining at least an upper secondary education, much higher than China and Mexico, which are at 255 and 35% respectively. Adding to that, Brazil has an aimpressive demographic outlook. Thanks to a declinein its fertility rate over the past several decades, its dependency ratio has dropped dramatically … Furthermore, Brazil’s share of working-age population is projected to rise for at least another decade. This is a luxury that most of the developed world can’t afford … Temer knew the public pension program was unsustainable and was looking to make some major reforms, including requiring individuals to work longer and reducing payouts …”
Some reading: In the story, “Secret recordings may be Brazilian democracy’s best hope — but also a growing problem,” has some fascinating detail, from The Washington Post.
In our Thursday post, we outlined Morgan Stanley’s case for 80% upside in oil producer Petroleo Brasileiro or Petrobras (PBR), the state-controlled producer.
JBS (JBSAY) the meat company and majority owner of Pilgrim’s Pride (PPC) at the center of the latest wire-tap that exposed Temer to corruption allegations, tumbled 12% this week on top of big losses last week. The shares are down 33% this year. A Brazil competitor in meat sales, BRF (BRFS), jumped 15% higher this week, and is up 13% this year. See our post Brazil Bribery Beef: JBS Sinks 31%, Pilgrim’s Pride Safe?
Among individual Brazil companies, other winners include pulp producer Fibria Celulose (FBR), up 11%, and airplane maker Embraer (ERJ), up 8%.The second worst performer after JBS was residential property developer Gafisa (GFA), down nearly 9% this week,
You can peruse all our recent free posts on Brazil, including: 38 Brazil Banks & Sovereign Face Rising Debt Risk, S&P Says, As Brazil Debt Risk Rises, Petrobras Issues Bonds 6 Reasons Petorbras Has 35% Upside