Worse, Not Better For Brazil ETFs

Around these parts, we try not to pick on or laud single ETFs, or a group of similar funds, too much. We try to be fair, equal-opportunity critics and givers of complements.

Brazil ETFs such as the group's marquee name, the iShares MSCI Brazil Capped Index Fund (NYSE:EWZ) are making that task difficult because bad news continues mounting for Latin America's largest economy.

To be fair, EWZ and the other Brazil ETFs are far from being the only LatAm offenders these days. Slowing growth and declining commodities prices have weighed on ETFs ranging from the Global X FTSE Colombia 20 ETF (NYSE:GXG) to the iShares MSCI All Peru Capped Index (NYSE:EPU).

However, it sure feels like Brazil has been the most prolific issuer of bad news to investors. There was the interest rate increase at the end of May, which prompted increased speculation Brazil is dealing with stagflation. There is the plunging real. The WisdomTree Brazilian Real ETF (NYSE:BZF) is off five percent in the past month.

Then there is the fact that EWZ has been the worst-performing of the four major BRIC single-country ETFs over the past month with a 12.4 percent loss. That is nearly 200 basis points worse than the next worst fund, the WisdomTree India Earnings ETF (NYSE:EPI).

Those may not be the worst factoids pertaining to Brazil and the corresponding ETFs. That group of funds was hit by a tidal wave of bad news Monday, sending the marquee names including EWZ and the Market Vectors Brazil Small-Cap ETF (NYSE:BRF) to new 52-week lows.

Standard & Poor's sees a decent chance that it will have to lower Brazil's sovereign credit rating, currently BBB, in the next year, Forbes reported. The Forbes piece cites Barclays as seeing a downgrade to BBB-, the lowest investment grade, but not to junk status.

But what if that prediction is wrong and S&P does take Brazil to junk status, the same demotion India is hoping to avoid. If India, currently rated BBB-, is not lowered to junk, but Brazil is, then the latter will become the only BRIC nation with a non-investment grade credit rating.

That would not just be bad news for EWZ and BRF, it would also hamper emerging markets bond ETFs with Brazilian exposure ranging from the iShares J.P. Morgan USD Emerging Markets Bond Fund (NYSE:EMB) to the Market Vectors LatAm Aggregate Bond ETF (NYSE:BONO). BONO currently allocates 20.5 percent of its weight to Brazil.

Alright, hypothesizing about Brazil getting a junk rating is just an exercise for now, but in the real world, things are still bleak for Brazil ETFs. Goldman Sachs lowered its 2013 GDP forecast for the country to 2.5 percent on Monday.

"The Brazilian economy remains trapped in a poor equilibrium of sluggish below-trend growth, high inflation, misaligned currency, eroded external competitiveness, and weak policy credibility," said Goldman Sachs economist Alberto Ramos in a note.

A growth rate of 2.5 percent is fine for those that want to own U.S. stocks and it would be downright stellar for those that own any number of Europe ETFs. GDP at 2.5 percent for an emerging market, however, is not exciting. Especially not when EWZ has a three-year standard deviation of almost 26.5 percent and BRF's is 28.5 percent.

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