Time to buy into Brazil’s dead money bet?

These are exciting times for a market that has lost 9.5% over the last two years between a sagging currency and a drumbeat of setbacks for the local heavyweights. That’s right, we’re talking about Brazil.

Image courtesy Artyom Sharbatyan: http://commons.wikimedia.org/wiki/File:Christ_on_Corcovado_mountain.JPGThe real — too strong, too weak — has been a death cycle for Brazilian mega-cap names like Petrobras (PBR, quote), Vale (VALE, quote) and Itau (ITUB, quote).

A bit of context: it took 1.54 reais to buy a dollar last summer. Now, the currency has declined to the point where it takes 1.89 reais to amount to the same greenback.

That decline should be a rallying cry for Brazil’s exporters, Vale in particular. But instead, the underlying tone indicates that this once popular market has turned poisonous: if you don’t have to invest there, you’re not going to be there. 

And if you need to invest in Brazil to meet benchmarks or index requirements, you probably aren’t happy. Even the once-defensive sectors like the homebuilders and agricultural names — see Gafisa (GFA, quote) and Bunge (BG, quote), respectively — have been crushed. 

Meanwhile, Dilma Rousseff’s government has become increasingly difficult for corporate interests to work with. Or more to the point, the government is too eager to “work with” these companies in the form of anti-competitive measures and outright interference in the name of social policy.

Why are we even talking about Brazil now? Because there is good news on the horizon.

The central bank is playing with the currency to find the sweet spot between “too strong” and “too weak.” They are clearly defending levels where we are now — just below 1.90 reais to the dollar — as their limit, as $18.5 billion in fresh dollar reserves over the last six weeks demonstrates all too well.

Buying that many dollars shows how hard they have been defending the real, but also how good this situation really is for the exporters.

Most traders expect Brazil to cut interest rates at least two more times before August. Rates are already at historic lows and Dilma seems excited in bringing down the cost of doing business even more. While normally this would send the Brazil hands screaming for the inflation exits, right now price pressure seems relatively tame.

So how do you play this? Avoid the mega-cap names that Dilma seems most interested in manipulating: PBR, VALE, ITUB. Between them, these three companies alone account for 37% of funds like EWZ (quote), so avoid the large-cap portfolios.

Instead, find mid- (BRAZ, quote) and even small-cap names (BRZ, quote) with a story and real earnings growth. Think infrastructure (BRXX, quote), shipping, packaging; the cellular names like TSU (quote).

These stocks have flown under the radar, but provide exposure to what is actually going on in Brazil. So far, they’ve beaten the big names — and aren’t asking anyone to catch a falling knife.

BRAZ in particular has been anything but dead money, outperforming EWZ by nearly 20 percentage points over the last two years.

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