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After A Rally, This ETF's Stocks Are Expensive

March 22, 2016 8:09 am
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In one of the most stunning reversals in recent memory for an emerging markets single-country exchange-traded fund, the iShares MSCI Brazil Index (ETF) (NYSE: EWZ) is up 31 percent over the past month.

EWZ's gain over that stretch is more than two and a half times that of the MSCI Emerging Markets Index. Impressive as it may be, the rally in Brazilian stocks has those shares looking richly valued relative to the broader emerging markets universe, an asset class that has been viewed as inexpensive for several years.

An expanding corruption probe in Latin America's largest economy threatens to ensnare current President Dilma Rousseff and her predecessor, Luiz Inacio Lula da Silva. So, Rousseff has proceeded to offer Lula, who was recently questioned by Brazilian authorities for his role in corruption at Petroleo Brasileiro SA Petrobras (ADR) (NYSE: PBR), Brazil's state-run oil company.

Related Link: Rousseff Is A Problem For Brazil Leveraged ETF

Valuations for Brazilian stocks, including many held by EWZ, are approaching a decade high as volatility in the often volatile emerging market rises and Latin America's largest economy continues contracting.

“An MSCI Inc. gauge of the nation’s shares is trading 12 percent above a measure of developing-nation equities, according to data compiled by Bloomberg based on estimated earnings. That’s the widest margin since 2006, when the gap surged in the midst of a commodities-led boom,” according to Bloomberg.

EWZ closed just under $27 Monday. In 2006, the ETF started the year trading over $41 before finishing over $47. Petrobras, a major holding in EWZ, trades at more than 35 times forward earnings. By comparison, Exxon Mobil Corporation (NYSE: XOM), the largest U.S. oil company, trades at 20 times forward earnings.

Bloomberg data indicate the only sectors in Brazil that trade at discounts to broader emerging markets benchmarks are consumer staples and healthcare. Brazilian materials names trade at triple the multiple of their emerging markets rivals, according to Bloomberg. Materials stocks are the fourth-largest sector weight in EWZ at nearly 9.5 percent.

Embattled Brazilian banks trade at a slight premium to their emerging markets counterparts. Financial services is EWZ's largest sector allocation at 36.5 percent.

Image Credit: Public Domain

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