Faint Signs Of Hope For Brazil ETFs

Believe it or not, the iShares MSCI Brazil Index (ETF) (NYSE:EWZ) has traded higher over the past month and currently resides nearly 13 percent above its 52-week low. That does not mean the largest Brazil exchange-traded fund and its peers are out of the woods, but some market observers are arguing Latin America's largest economy is showing modest signs of improvement.

A problem for EWZ is weakness in Brazilian bank stocks, which is particularly problematic when considering the sector's issues against the backdrop of some of the developing world's highest interest rates. EWZ's financial services weight is about 33 percent, or more than 1,200 basis points larger than the ETF's second-largest sector allocation, consumer staples.

Brazil's Economy

Brazil remains mired in what is now a lengthy recession, but recent PMI data indicate that condition is moderating a bit.

Markits composite PMI survey covering both manufacturing and services remained deep in contraction territory in January, the extent of the decline being highlighted by Brazils manufacturing sector recording the lowest PMI reading of all countries covered by Markits surveys in January, according to the research firm.

Although the survey signals an ongoing substantial downturn in the economy, the rate of decline has therefore eased. The latest reading is commensurate with gross domestic product declining at a quarterly rate of approximately 1.0 percent at the start of the year, steep but less than the 2.1 percent and 1.7 percent rates of decline seen in the second and third quarters of last year respectively (fourth quarter GDP numbers have not yet been published).

Higher interest rates and inflation coupled with rising unemployment are factors pressuring the credit quality of Brazilian banks at a time when the country's state-controlled oil and iron ore producers are under significant duress.

Add to that, the potential impeachment of President Dilma Rousseff, something previously viewed as a positive catalyst for Brazilian stocks, has lost momentum in recent weeks after being seen as a possibility late last year.

The IMF, which downgraded its outlook for Brazil as economic data rapidly deteriorated last year, is currently projecting a 3.5 percent drop in GDP in 2016 after an estimated 3.8 percent decline in 2015, with a stabilisation of the economy predicted in 2017. However, the upturn in the PMI in January bodes well for an earlier lift out of recession than the IMF is estimating, said Markit.

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