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Investing in Brazil for all the Wrong Reasons

Calla is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Seeking Alpha published An overly optimistic piece on Brazilian stocks last week and listed the main Brazilian ETF as a defensive move, just as The Washington Post and CNN mulled over mediocre news from Latin America’s biggest economy. Brazilian stocks have floundered in 2012 with falling profits, low growth, and rising inflation. Despite low returns, Brazilian stocks are not cheap by most metrics and macroeconomic indicators are mixed on what 2013 holds. Brazilian stocks may be an alluring long term bet on global growth, but contrary to Seeking Alpha’s posts, they are a riskier alternative to waiting out the U.S. fiscal cliff melodrama.

Two Big Risks

Growth
Brazil will probably eke out 1% GDP growth this year, below the boring 2-3% estimates that economists put out at the beginning of the year. Throughout 2012, the Central Bank kept publishing estimates for quarterly and yearly growth that suggested that Brazil was picking up again, only to have the actual quarterly numbers come in significantly lower. The Central Bank is now assuring the press, populace, and business community that 2013 will feature a respectable 4% growth rate. There is no reason to believe that the Central Bank is purposefully inflating its estimates, as private economists publish similar estimates, but the 4% goal is far from sure. Even if the Central Bank gets it right this time, 4% is decent emerging market growth, barely justifying the term “rebound” and still not enough to justify Brazil’s high valuations.

Valuations
Despite a disappointing year, Brazilian companies still trade at high valuations. According to BusinessWeek, Brazil’s main stock index, Bovespa trades at a PE of 19, the highest of the BRIC countries. Seeking Alpha suggests buying into the ETF iShares MSCI Brazil (NYSEMKT: EWZ); while iShares is the easiest way to get exposure to the Brazilian market, it is not the best way. The fund’s main holdings are natural resource companies, banks, and telecoms. Its largest holdings, Petrobras (NYSE: PBR) and Vale (NYSE: VALE), have taken huge hits this year on low earnings, multiple downward guidance revisions, falling demand for core products, and rising labor, investment, and legal costs.

For decades, Brazilian banks relied on high interest rates for profits, but the government has aggressively slashed base and consumer rates this year, plans to keep them low, and just began investigating new bank fees. Likewise, the fund’s telecom holdings were nearly all hit with fines and orders to invest hundreds of millions in infrastructure upgrades this year. Reasonable interest rates and a competitive telecom sector will benefit the Brazilian market in the long run. However, chances are you will not benefit as a shareholder while extractive industries, banks, and telecoms adjust to changing and expensive orders from the central government. The best way to invest in Brazil is to carefully pick and choose reasonably valued companies, not buy into all of the turbulence through an ETF.    

One Good Reason: Long Term Global Growth

The Brazilian government has been aggressively and publicly positioning Brazil as a global leader, offering aid to neighboring countries, heading U.N. missions, and partnering with African and South American countries to develop infrastructure, often after U.S. aid was rejected. Brazilian companies have jumped on board. Petrobras and Vale operate lucrative long term sites in countries where other natural resource companies are routinely nationalized. Brazilian brands populate South American households and are actively expanding into other markets: AmBev (NYSE: ABV) brews Uruguay’s, Argentina’s, and Bolivia’s most popular beers as well as Brazil's, while Brasil Foods places products in over 100 countries. If middle income countries keep growing, Brazilian companies are well positioned to snag market share outside of Brazil.

However, this optimistic take relies on a few macroeconomic trends and some hope, whereas the presented risks rest on hard numbers for individual companies. Brazilian stocks may hold good returns for long-term and risk acceptant investors, but Brazil remains a risky long-term play – not a good and quick alternative to short term uncertainty in U.S. markets.


CallaMarie owns shares of Companhia Vale Ads and Petroleo Brasileiro S.A. (ADR). The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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