What Is Going On Down In Brazil? (EWZ, EEM)

Emerging markets investors are scratching their head on Brazil and, if they have not filed their nails, they are probably drawing a little blood to match the carnage in the Bovespa.

The overall mood among Latin investors on Brazil is admittedly pretty terrible. But despite all the gloom from the central bankers, valuations are definitely interesting here after a 20% to 30% correction in some key names — especially in the domestic consumer sector.

Underperformance to the broader emerging markets asset class almost seems technical at this point. Figure that the Bovespa is down 9% in the last three weeks, whereas the S&P 500 has been flat and emerging markets have overall been down only 3% to 4%.

Major brokers say this is all about ETF flows, which are receding massively in the last few weeks. With $10 billion flooding back out of the asset class in the last two weeks, flows tell a lot of the story on Brazil in particular, simply because alone among the BRICs — Brazil, Russia, India, China — Brazil is actually open during U.S. trading hours, and is the biggest emerging market to more or less share the Wall Street trading day. Why are ETF flows so important? Barclays is a Top 5 holder in just about every major Brazilian name, which reflects the way the iShares MSCI Brazil Index ETF (NYSE:EWZ) has become such a top vehicle to play this market.

According to Morgan Stanley, EWZ usually trades at a slight premium to its NAV — due to IOF taxes, this fund used to move anywhere between parity and 2% above its underlying assets without becoming a bona fide arbitrage opportunity.

However, recently this premium has collapsed to “only” 1% after pushing near its limit for the last five months. This again reflects the rise of the ETF channel as the way Brazilian stocks are traded, and not so much anything inherent in the market itself.

And it is not just EWZ. Take a look at the iShares MSCI Emerging Markets Index (NYSE:EEM) as the biggest example of where ETF redemptions have hit the overall asset class. The number of EEM shares redeemed lately is now just 25% from its all-time credit crunch high.

Written By Tim Seymour From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.

About Tim Seymour: Tim is a founder of Emerging Money. He is a founder and Managing Partner at Seygem Asset Management, and The Emerging Markets Contributor to CNBC. Seygem Asset Management focuses on investing throughout the global emerging markets asset class. With a view that emerging and developing economies will continue to outpace the economic growth and advancement of developed economies, Seymour has devoted a career to investing in the dominant markets of tomorrow, today. Seymour’s career has included significant experience in both alternative asset management (hedge funds) and capital markets, having launched two hedge funds, and built the largest Russian broker dealer in the USA. Seymour started his career at UBS, focusing on international credit (cash, swaps, forex) in a specialized hedge fund group (New York). Seymour completed the firm’s training program after graduating with an MBA in international finance from Fordham University. Seymour received his undergraduate degree at Georgetown University.

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