VanEck Vector Brazilian Small Cap ETF: Ideal Conditions (NASDAQ:EWZS)

Brazil is the country of the future. – Charles de Gaulle

If you happen to be a subscriber of The Lead-Lag Report, you’re familiar with my macro article from last week. Emerging Markets Investment Case 10 Years After U.S. Large Caps Weak and Lost Performance The quantitative easing and zero interest rate spectrum has proven unfavorable for emerging markets outperformance. Going forward, EM will not have to deal with these hurdles for the foreseeable future.

It’s not just the third quarter decline. There are also large valuation differentials and burgeoning commodity cycles to support the investment case. As an aside, if you’re interested in finding interesting opportunities in the commodities space, consider listening to his recent Lead-Lag Live episode with Andrew Hoese, which highlighted a variety of opportunities worth pursuing. please.

When it comes to commodities and cheap valuations, one EM that reflects these themes fairly well is Brazil. One way to play in Brazil is to pursue the lesser-known VanEck Vectors Brazil ETF (BRF). This is the more popular iShares MSCI Brazil Small-cap ETF (NASDAQ: EWZS); Utilities are the top sector for the latter, while the industrial sector complements the top sector for the former. If you’ve been following the development in The Lead-Lag Report’s timeline, you’ll notice that Lumber also recently joined the party to talk about the conditions that would support his play on Risk On.

In a Twitter Spaces chat with a Brazil-based equity strategist, we explored why the region has been attracting so much foreign capital flow in recent times. Fernando Ferreira believes Brazilian stocks may have received him nearly $20 billion in January alone.

Some of the additional interest can be explained by the fact that Russia, a key cog in the BRIC Universe, has become uninvestable. At the same time, there is still a huge lack of trust around China’s policies and disclosures. India has also recently been hit with corporate governance issues at the Adani Group, weakening sentiment for its cohort. This may be a peculiar issue, but nevertheless it should be remembered that India remains one of the most expensive EMs. For reference, the flagship iShares MSCI India ETF is trading at a very high P/E of 19x. Conversely, the BRF trades at just 7.3x P/E.

In fact, Brazilian stocks were at similar valuations a year ago and EPS is also supported by ample commodities-related earnings, so no re-ratings have taken place. The ambiguity surrounding last year’s tough Brazilian elections was another reason for the lack of a reassessment.

Speaking of elections, the winner, leftist candidate Luis Inacio Lula da Silva, will try to revive the economy by pushing for some populist measures and fulfilling some of his campaign promises. He is reportedly on track to deliver on his $32 billion plan, which includes social spending and investment initiatives.

Given that the country has worked hard to bring its total debt as a percentage of GDP down to a level of 73.5%, the growing budget deficit may be shameful. It is also questionable whether the new fiscal plan will re-stimulate inflation levels that appear to be declining. IMF data show that both headline and core inflation fell as Brazil took the lead in raising rates very early in the cycle.

Brazil’s central bank appears to be tightening for now, but it’s worth noting that both real and nominal interest rates are among the most attractive. Given this current state of affairs, investors will think twice if they are considering shorting the Brazilian Real. What’s more, as of now, investors don’t appear overly concerned with financial management of things as spreads on Brazilian foreign currency debt relative to US Treasuries tend to tighten.

In the long term, the BRF’s heavy industry portfolio could also benefit from China’s support to develop Brazil as a manufacturing hub, as opposed to India.

Conclusion

Finally, also consider that technically Brazilian small caps offer tremendous value in the wider Brazilian universe. A ratio that captures the strength of small caps as a function of Brazilian stocks looks like it may have formed a triple bottom around the 0.45 level. This is the area he visited in 2009 and 2016 before seeing any recovery.

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