Plenty Of Reasons To Be Bullish On Brazil (EWZ)

Image of Brazil flag flying

From Invesco: Just as Brazil seemed to be recovering from its worst recession in history, it took another hit last May. A secret recording surfaced of President Michel Temer allegedly discussing a scheme to pay hush money to jailed former speaker of the lower house, Eduardo Cunha.

Since then, President Temer was cleared in early June of campaign finance violations, but was charged in late June with corruption related to a bribery scheme. This ongoing political turmoil has delayed the approval of much-needed pension and other reforms. And yet, Brazil’s current fundamentals are much stronger than at year-end 20161, with a benign inflation outlook, strong companies and a healthy balance of payments.

For us, as bottom-up investors, all of this adds up to potential opportunity. Below, I discuss the positive signs that the Invesco International and Global Growth team sees in Brazil.

1. Political changes could be positive for reform

Many pundits are predicting that President Temer will not remain in power. If he were to step down or be removed, Rodrigo Maia, the leader of the lower house, would likely assume the role of president. This could potentially be a positive for the reform agenda. The market seems to agree — against this backdrop, the Bovespa Index is already up 8.6%2 in US dollar terms after the first 15 trading days of the third quarter.

Longer term, the flushing out of Brazil’s corrupt politicians would be a definite positive. The next presidential election in October 2018 may be a turning point if the populace abandons traditional politicians and looks toward outsiders who could give Brazil’s government a breath of fresh air.

2. Inflation has fallen, and rates may follow

Of note, inflation has come down from nearly 11% in January 2016 to 3% in June 2017.2 This improvement gives the central bank room to consider additional interest rate reductions. While rates have already come down 400 basis points since easing began in October 2016, we expect more over the next few months.

3. Businesses are stronger

Compared to one year ago, Brazilian companies are now much healthier. The ratio of net debt to earnings before interest, taxes, depreciation and amortization (EBITDA) improved to about 2.2x in the first quarter of 2017 from 3x one year ago. Interest coverage improved to about 2.7x from 1.4x one year earlier.3 Brazilian corporations benefited from lower interest rates and saw improvements in operating results.

Our outlook: Bullish for the long term

There is little doubt that the ongoing political turmoil is an economic setback, and we expect it to create some short-term market volatility. However, we continue to be bullish on Brazil in the longer term. Based on underlying corporate fundamentals, Brazil is home to many high-quality companies that have continued to grow despite the negative political backdrop. As long-term investors, we believe market volatility provides opportunities to invest in desirable companies at more attractive prices. In addition, current valuations look attractive. Based on the MSCI Brazil Index, the free cash flow yield for the next 12 months has reached 7.6% (a 10-year high)4 as companies have benefited from lower debt servicing costs and improved profitability.

Based on our bottom-up company level analysis, we have taken advantage of the recent event-driven market pullbacks and increased our allocation to Brazil in Invesco International Growth Fund.5

1 Source: Brazilian Institute of Geography and Statistics, as of June 30, 2017

2 Source: Bloomberg L.P., as of July 25, 2017

3 Source: Credit Suisse, “Brazilian Banks,” June 29, 2017. Proprietary analysis based on Economatica database.

4 Source: FactSet Research Systems

5 As of June 30, 2017, the allocation to Brazil was 4.72% of the fund’s total net assets.

Important information

A basis point is one hundredth of a percentage point.

The Bovespa Index, considered representative of Brazil’s equity market, is composed of stocks that are traded on the Sao Paulo Stock, Mercantile & Futures Exchange.

The MSCI Brazil Index is composed of large- and mid-cap segments of the Brazilian equity market.

Free cash flow yield is a method of calculating a company’s value by dividing free cash flow by enterprise value.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

Invesco International Growth Fund risks

Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

Stocks of medium-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.

The iShares MSCI Brazil Index ETF (NYSE:EWZ) closed at $38.30 on Friday, down $-0.13 (-0.34%). Year-to-date, EWZ has gained 15.81%, versus a 11.71% rise in the benchmark S&P 500 index during the same period.

EWZ currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 23 ETFs in the Latin America ETFs category.

This article is brought to you courtesy of Invesco.