Will Brazil ETFs and Petrobras Breathe Easy After the Election? - ETF News And Commentary

There are several factors in the Brazilian economy that could make or break the related exchange traded products. Among these, the 2014 FIFA World Cup, a slowing economy, stubborn inflation, a series of rate hikes, high levels of unemployment, excessive red tape and a presidential election are worthy of mention.  

Surprisingly, ignoring all other economic drivers, election turned out to be the name of the game in Brazil. Brazil equities ironically gained the day the country announced a technical recession in the first half of this year. Not only this, Brazil equities performed superbly the day after Brazil failed to make it to the World Cup final (read: Ignoring World Cup Loss, Brazil ETFs Tackle Rousseff Concerns).

Basically, each and every failure of Brazil hinted at the diminishing popularity of the present president Dilma Rousseff who is seems unlikely to be re-elected in the upcoming general election on October 5, going by popularity polls.

Bright Days Ahead for Brazilian ETFs?

Brazil's GDP shrank 0.6% in Q2 following a 0.2% contraction in Q1. The FIFA World Cup seemingly failed to give its expected share of boost to the economy. Tumbling investment was held responsible for this growth shrinkage.

Investments fell as much as 5.3% (quarter on quarter) in the second quarter versus 2.8% decline in the first quarter. Notably, fixed investments have been declining for the fourth successive quarter (read: Inside the Continued Brazil ETF Slump). 

This technical recession surfaced for the first time since the global financial malaise in 2008–09. Renowned research house Barclays has cut its GDP forecast for Brazil to 0.1% for the year, from 0.7% with downside risk being prevalent (read: Brazil ETFs in Focus on GDP Contraction: Any Hope for 2014?).

A research agency Capital Economics reduced its expectation for Brazil's full-year GDP growth from 1.5% to 0.2%. The research agency indicated that any monetary easing to spur growth would turn into a bad policy as Brazil's credit profile has been already spoilt, having grown at a higher rate than its nominal GDP.

While all these data have been quite discomforting, stock markets might be benefitting out of these. Quite expectedly, this lackluster number will go against Rousseff's favor in the forthcoming election as she has already been losing popular support. Rousseff's failure to speed up economic growth will become extremely prominent which in turn will likely help Brazilian stocks and ETFs.

Is Petrobras Awaiting a Turnaround?

Petrobras is the largest publicly traded Latin American oil company, dominating Brazil's oil and gas sector. The stock is the second largest holding of the biggest Brazilian ETF iShares MSCI Brazil Index Fund EWZ with more than 7% share.

The Brazilian government, the company's majority shareholder, has a history of political interference in Petrobras' affairs. Per that intervention, Petrobras has been asked to sell gas at a loss to rein in on inflation. If this was not enough, this Brazilian energy giant announced in late June that it will have to shell out billions of Brazilian reais for additional production rights at its Buzios field and nearby areas.

Though this discovery has substantial long-term potential for a company that has been trying to increase production, the costs associated with the find will likely raise Petrobras' debt burden at the initial level, which is already quite high.

In such a situation, Barclays commented that, once the election is over, pressure on Petrobras might be lifted as the newly elected president will not have to battle voter dissatisfaction before 2017. The bank expects the next government to let Petrobras hike domestic product prices in 12–24 months following the election without putting a lot of political interest at risk.

The next ‘election cycle' is less likely to begin before late 2017, per the bank. In short, Barclays believes that following the end of election, Petrobras will get some relief irrespective of who the winner is (read: 3 Brazil ETFs Surging This Year).

Bottom Line

We currently have a “Sell” rating on EWZ. However, investors still interested to play the Brazilian arena in order to cash in on Dilma's dimming popularity can tap small cap ETFs like iShares MSCI Brazil Small-Cap ETF (EWZS) and Market Vectors Brazil Small-Cap ETF (BRF) as well as the infrastructure ETF like EGShares Brazil Infrastructure Index Fund (BRXX) with a short-term focus as the trio carries a Zacks ETF Rank #3 (Hold). As a caveat, long-term investors are advised to stay on the sidelines and wait for economic stabilization in this important emerging market.
 
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