In this, the latest in our Investment ViewPoint: Analysis series on emerging markets, we shift our focus from the Asian powerhouse of China to the country famous for coffee, samba and football – Brazil.
As part of the quartet comprising the BRIC nations, it could be argued that Brazil has been overshadowed in terms of international economic focus in recent years. The popular stories about population explosions in China and India and the subsequent economic power they could wield are well versed. Russia, with its general proximity to the UK, a closer focus on its recent politics and the new trend of Russian oligarch-cum-celebrities taking the media spotlight, has carved out a more prominent profile in the mindset of UK investors. However there is just as intriguing a story to Brazil and here we will investigate the current economic health of the nation and its future potential.
So what do we know of Brazil? Ranked as the world’s 10th largest economy by the International Monetary Fund in 2008 with a GDP of $1,572bn, the nation has the 5th largest global population and land mass. Both statistics are important, the first gives an indication of the size and strength of the country’s labour pool, the second is a hint towards the scale of the rich seams of commodities Brazil can lay claim to, a feature shared by many of its Latin American neighbours and pivotal to Brazil’s economic DNA. Indeed, Brazil is a major exporter of coffee, soybean, iron ore, orange juice and steel and has increased its presence on the international commodities markets in recent years. As we will discuss, commodities are intrinsically linked to Brazil’s economic health. Otherwise, Brazil is recognised as having large and developed agricultural, mining, manufacturing and service sectors.
Few economies escaped the bite of the credit crisis and Brazil was no exception. Along with other Latin American nations, Brazil has a high exposure to international trade and export so was hit particularly hard by the global recession. Brazil’s main equity index, the MSCI Brazil IndexSM, fell by more than 70% across 2008 but as with other prominent emerging markets, recovery has commenced as illustrated in the chart below. Since April 2009, the index has clawed back some of last year’s losses and a recent report* suggests that Latin America is now moving out of recession and back into the upswing phase of the business cycle. The report’s Global Economic Climate Index, an aggregate survey of businesses’ current situation and expectations, showed three of the BRIC nations, China, India and Brazil, leading recovery with the highest ranked index levels, all above five points (measured on a 0-10 scale).
Successfully combating the global recession has required strong, direct action from policy makers and once again, Brazil is no different. Like most economies the government executed a series of interest rate cuts and also provided $51bn from its reserve requirements to fund the banking sector during the initial stages of the credit crisis. They also took steps to stave off domestic sales inertia by making short term cuts to taxes on items such as motor vehicles and household electrical goods, a successful move that saw sales return to pre-crisis levels. More recently Brazilian policymakers have shifted focus to future stimulus. Seeing opportunity emerge from the global recession, they are intent on boosting domestic productivity and growth.
The main policy driver will be cuts to the country’s high labour costs, including the removal of a 25.5% contribution of employee’s gross salary to a range of welfare funds, aimed at improving the effectiveness of the national workforce and enhancing Brazil’s ability to compete in international markets across a range of industries.
So what does the future hold for Brazil? It certainly appears to be bright, sharing the positive outlook for emerging markets generally, and there is economic logic behind this. It is anticipated that Brazil will be one of the principle economies to directly benefit from growth in the Asian region, primarily led by China. China has now surpassed the U.S. as Brazil’s main export destination, with high demand for Brazil’s commodity outputs expected from the region, particularly agricultural products like soybean. Indeed, there is evidence to suggest that Brazil’s performance closely maps to that of China and other Asian emerging markets, albeit this can sometimes be staggered.
Of course, China’s performance has to be taken into consideration and the recent wobble in Chinese markets witnessed throughout August is a perfect example of the volatility emerging markets are susceptible to, as we referred to in Investment ViewPoint: Comment - “No immunity from uncertainty”. So while optimists will point to Brazil’s growth shadowing that of China and the Asia ex-Japan region, investors should be mindful that any performance dip from this area could also potentially impact Brazil.
This is not to say that it will be an easy ride for Brazil on China’s coat tails. As with all economies it will face many challenges in both the short and longer-term. For example the current tax breaks on domestic goods are anticipated to end soon, with sales likely to be impacted.
Looking further ahead, there is an election due in 2010. Jostling for political position is already underway and there is always the risk that policy action could take second place until a new electoral mandate is delivered. Lastly, with Brazil’s aforementioned strength in commodities, the economy is likely to be more heavily influenced by cycles therein, both positive and negative. In fact some analysts go so far as to consider an investment into Brazilian equities as being closer to commodities in terms of asset allocation.
It is interesting to note that the MSCI Brazil IndexSM
has a 25% weighting towards Petrobas, the Brazilian oil company and many
other significant holdings are fundamentally linked to commodities, so
Brazil’s correlation and sensitivity to commodities markets is apparent.
You can read more about Brazil’s current economic outlook in the latest issue of Barclays Wealth Compass - available from the Research Centre when you login to your account.
In our previous Investment ViewPoint: Analysis we discussed the possible approaches you could take to emerging markets if you thought it was the right time to invest and this would apply to any investment in Brazil that was being considered. As before, there are a variety of ways to get investment exposure to this particular emerging market.
A product with broad emerging markets exposure would be the first to consider.
For example, an Exchange Traded Fund (ETF) like the iShares
MSCI Emerging Markets (IEEM) has almost 15% of its portfolio invested in
Brazil. Likewise a managed fund such as Aberdeen Emerging Markets has
a similar level of exposure.
An investor could home in further and consider a BRIC-related investment,
which will naturally have a heavier weighting towards the 4 BRIC nations,
with Brazil being one of them. The iShares FTSE BRIC 50 (BRIC) for example has
over 40% exposure to the Brazilian economy. Contrast this to Allianz RCM
BRIC Stars fund which has an exposure to Brazil of around 23%.
However, perhaps the most direct way to invest in the country is through
a fund fully focussed on the Brazilian economy. Consider the iShares
MSCI Brazil (IBZL). An ETF that offers diversified exposure to over
60 of the leading Brazilian companies, the iShares MSCI Brazil (IBZL)
is designed to track the MSCI Brazil Index SM.
You need to bear in mind that:
Download
the latest factsheet for the iShares MSCI Brazil (IBZL)
The MSCI Brazil IndexSM and subsequently any ETFs that track it, such as the iShares MSCI Brazil (IBZL), has a heavy weighting to a single company, Petrobras, the part nationalised Brazilian oil company (over 25% as at 1 September 2009). Many of the other large holdings in the index are commodity producers and exporters. This goes to further emphasise the intrinsic link commodities have to Brazil’s economy and potential investors should be aware of this when considering an investment.
Brazil is clearly a nation with a role to play in the future of the global economy. Flamboyant in nature, there are obviously risks to be taken into account when considering an investment into this emerging market, but the potential returns could be healthy. So if you think that your portfolio is missing a touch of Brazilian flair then the iShares MSCI Brazil (IBZL) could be right for you.
Barclays Stockbrokers does not give advice. If you are in any doubt as to the suitability of investments into emerging markets or into the specific market of Brazil to your own investment needs, please seek independent financial advice.
* Based on quarterly survey of businesses current situation and 6 month outlook, prepared by Brazilian university and Business School Fundacao Getulio Vargas and University of Munich’s IFO institute for economic research
Page last updated: 11 September 2009
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