Be Careful in Brazil

 | Apr 18, 2013 | 11:34 AM EDT  | Comments
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EWZ

Emerging markets have had their fair share of volatility in the past few years. Of the big four emerging economies -- Brazil, Russia, India and China -- Brazil has remained a net exporter of goods and services, and its economy has made tremendous strides.

The country's GDP seems to be growing at a very steady upward trajectory. Government debt as a total percentage of GDP is coming down but is still high. And the high inflation rate and discount rate make the country's currency, the real, a play on the long side with a carry trade. Brazil remains a net exporter of goods, and retail trade remains very strong.

The issue with Brazil is twofold. It is a large net exporter of commodities, specifically energy. The drop in commodity prices is bearish for Brazilian energy companies as supply increases. Demand is slowing from the countries it exports to, and that in turn hurts Brazil's GDP.

A second problem is that consumer spending, which was the main driver of growth, is now lagging. In 2012, Brazil grew at just 0.9%, its slowest growth in three years, despite forecasts from its government that were projecting around 4.5% growth. Most of the income went toward servicing the debt load, which has come down sharply.

From a long-term view, the charts look favorable, in that GDP has been growing sharply, government debt has come down, and inflation is heating up while interest rates remain low. Exports of goods and services were looking great, and retail trade was booming. All of that has come to a brief halt, and no one knows how long it will last. For the time being, it pays to remain cautious.

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The iShares MSCI Brazil ETF (EWZ), which represents the broad Brazilian stock market, has been in a very volatile state. It's in a sideways zone with very wild swings followed by negative on-balance volume. The charts point to a bearish price action going forward. When you have negative on-balance volume and an unfavorable outlook, it is best to just stay away.

The EWZ stands at $52.51 and is looking down toward a $45.50 price target, which it could reach if net exports continue to slow down and companies within the Brazilian stock market continue to feel the pain. All signs from both charts point to staying away.

Taking a long-term view of the history of the Brazilian stock market, you can see volatility, especially within the last 10 years. We saw the highs in 2008 and almost made it back in 2011, only to have another sharp drop. Volatility like this should be absorbed only by traders who have very active strategies and can stomach the pains and gains alike.

Volatility has remained steady for the past few months and is now looking to edge higher, making a rounding bottom. It is definitely something to monitor.

Brazil has had a fantastic run. It remains the seventh-biggest economy in the world. However, after the run-up of the past 20 years, it has felt a very strong slowdown in growth. Its currency remained a bright spot in the carry trade, as forex traders would borrow cheap and go long the Brazilian real. But credit conditions around the world have changed, leading to slower growth and lower export demand. And Brazil's consumer demand has slowed down as the government tries to reduce the debt load.

From the technical side, it has been a volatile market that goes sideways with sharp peaks and troughs. The negativity in the on balance volume indicator means that net selling outweighs buying, and overall sentiment is negative. Remain cautious on Brazil until its broad stock market indicates which way it will go. 

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