The stock market seems to be capable of shaking off anything these days. It was briefly rattled by the situation in Ukraine, but it recovered very quickly. Initially, the feeling across Wall Street was that we would see selling when the Fed began to taper the pace of bond buying, but that event has come and gone with little effect.
Earnings season has come and gone with yet another round of manufactured profits and no revenue growth, as buybacks and layoffs are still the keys to earnings growth. The market just shakes it off and maintains its laser-like focus on low interest rates and continues its upward climb.
Let's look at which sectors and regions have missed the party and refused to move higher during what has been a global stock market rally for the past few years. I am a big fan of John Templeton's advice to buy at the point of maximum pessimism, but gloomy outlooks have been tough to find during a period of Fed-fueled optimism. This morning, I ran a screen to see what was not working over the past year, to see if any potential bargain opportunities could be uncovered.
When I run this screen, what really leaps off the page is that Brazil is not leaping at all. The onetime emerging-markets darling nation has fallen on tough times, and the equity markets reflect the growing unpopularity. The iShares MSCI Brazil ETF (EWZ) is down 28% over the past year, even as the MSCI All World Index ETF (URTH) has gained 18% and the S&P 500 has roared ahead by 22%. Brazil's situation is similar to that of the U.S. in the 1970s: high inflation and a weak economy. It does not look like things will improve anytime soon, as a recent survey of economists found that they are lowering their growth outlooks for this year and for 2015.
Many observers, myself included, had hoped that the World Cup and the 2016 Olympics would provide a boost to Brazil's economy, but it has not happened. The Brazilian economy is centered on commodities, and its largest trading partner has been China. As China's growth has slowed and many commodities have developed a surplus, the effect on Brazil has been devastating to corporate profits and ultimately to Brazilian equity prices. In spite of demonstrations last year, it looks as though President Dilma Rousseff will win re-election in October and continue the nation on the same path it has been on since the rally in the "BRIC" countries -- Brazil, Russia, India and China -- fell apart amid the financial crisis.
Eighty-five Brazilian equities are traded in the U.S. Of those, 64 are down over the past year, 52 of them are down more than 20%, and 36 of them have declined by 30% or more. The list of losing stocks includes most of the infrastructure stocks, such as electric companies, energy providers, water companies and telephone companies, as the weak economy and over-regulation and control by the government have caused profits to evaporate at these essential companies.
I cannot seem to find any strategist or analyst who has a kind word to say about Brazilian equities right now. Michelle Gibley, an international strategist at Charles Schwab, recently told The Wall Street Journal that "the problem is cheap is great, but there just doesn't appear to be a catalyst for a rebound in the market." She doesn't believe the political will exists to enact the reforms that are needed for the economy and market to recover, and she says we could see more downside in Brazilian equities.
Luis Stuhlberer, the head of Credit Suisse Hedging Griffo, a large Brazil-based asset management firm, suggested that we would see a slowdown of outside investment in Brazil due to poor fiscal policies.
If you took a 10-year view and bought U.S. stocks in the middle of the 1970s, you experienced short-term losses as the economic situation continued to deteriorate. However, a decade later, you would have had huge gains from the stocks you purchased amid the pessimism. While I believe it will be a very bumpy ride, the same situation exists in Brazilian stocks today.
Brazilian stocks are unloved, and they are cheap. Stocks such as Companhia de Saneamento Basico do Estado de Sao Paulo (SBS), the water utility, and Petrobras (PBR), the large government-controlled oil company, may decline further in the short run, but 10 years from now, I expect they will trade at several multiples of the current depressed stock price. I feel the same way about the Brazilian electric companies such as Centrais Electricas Brasileiras (ELP) and banks such as Banco Santander Brasil (BSBR).
Amid the "don't fight the Fed" optimistic faith in equity markets around the world, Brazil is one of the few places where I can find the pessimism and angst that usually indicate a long-term buying opportunity. I am adding to my positions in leading Brazilian equities very slowly, but I am a scale buyer with a very long time frame.
