Brazil has been a beneficiary of the ongoing trade war between the U.S. and China, but it has struggled to grow its economy at the same time. That may be changing however as record low interest rates and changes in certain rules have started to make an impact.
The Brazilian Institute of Geography and Statistics announced on Tuesday that the third quarter GDP grew by 0.6% on a quarter over quarter basis and it grew by 1.1% compared to a year earlier. This is the fastest GDP growth rate for the Brazilian economy in the last year and a half.
Brazilians were frustrated with the leadership of the country and elected pro-business President Jair Bolsonaro in 2018 and he took over the reins on January 1 of this year. Since then the administration has changed a number of laws in an attempt to boost the economy.
The changes include an overhaul of the pension system, distribution from a forced savings account (similar to unemployment benefits), and falling interest rates. The central bank of Brazil has made three rate cuts this year with another one expected next week. The current rate is at a record low 5%. The bank has been able to do this as inflation has been very low in the South American country.
With the U.S. and China continuing to negotiate a trade deal, two of Brazil’s biggest exports, iron ore and soybeans, have been in the spotlight of the trade war. Brazil is the second largest exporter of soybeans in the world, second only to the U.S. China is the largest importer of soybeans in the world, accounting for 65% of soybean imports globally.
With interest rates falling, the Brazilian real has fallen against other currencies and that has benefitted exports as well. The real is trading near a 10-year low and that got the attention of the Trump administration and put a target on Brazil. In an early tweet on December 2, the President threatened tariffs on aluminum and steel exports from Brazil because the country’s currency has declined so drastically.
With the news being mixed news for Brazil, the GDP being better than expected, but being the target of potential tariffs, the Brazilian stock market jumped. This seems to suggest that investors put more emphasis on the GDP report than they did the possible tariff news.
The Brazilian market has outperformed the S&P 500 over the last five quarters with a gain for the Bovespa of 37.3% since October 1 last year. The S&P has gained 6.9% during the same period. However, the Bovespa has been more volatile during 2019 with a big decline from mid-March through mid-May and from early July through late August.
If we look at the iShares MSCI Brazil Capped ETF (NYSE: EWZ) as a proxy for the Brazilian market, we can see that the fund has been trending higher since September 2018. The outperformance for Brazilian stocks really came during the fourth quarter of last year as the S&P fell sharply but the EWZ was more stable.
The EWZ has been in a pretty clear upward trend so it will be interesting to see what impact a possible tariff would have. The initial tweet was just a threat of tariffs, but an actual action could have a negative impact on Brazil’s GDP and the positive momentum in the economy.
President Bolsonaro was caught off guard by President Trump’s tweet as he has made it a point to have a solid relationship with the U.S. president, but that could change now. Bolsonaro has been under some pressure domestically as the turnaround in the economy hasn’t been big enough or fast enough for some people. He has also come under fire for his pro-business policies that have allowed major deforestation of the Amazon.
The new developments in trade between the U.S. and Brazil will have a huge impact on Brazilian stocks as the U.S. is the second largest importer of Brazilian goods. If you are considering an investment in the EWZ, I would certainly do so with the intention of keeping a close eye on the fund. If the fund were to fall below its trend line or below its 104-week moving average, I would consider that to be a sign that the upward trend was over.