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Is It Time to Buy the Brazil ETF (EWZ)?

EWZ ILF PBR

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Over the past two years, Brazil has shown weakness among the four BRIC (Brazil, Russia, India and China) nations due to low productivity and heightened inflation. The economy expanded at a meager rate of 0.9% in 2012, the slowest in three years. This slow growth pushed Brazil to the seventh position, behind Britain, in terms of total size of its economy (read: Are BRIC ETFs in Trouble?).

Now, with manufacturing growth, higher retail sales, increasing consumer spending as well as robust domestic demand, the Brazilian economy appears to be on the path to recovery. This economy is expected to grow 3.5% this year and 4% in the next, as per the International Monetary Fund forecast.

The bright outlook comes mainly from a revival in investments that increased in the last quarter after declines in four consecutive quarters. Additionally, the government is taking several steps to boost growth in the country with tax cuts and cheap investments.

It is also seeking a flexible monetary policy that could lead to possible interest rate hikes in order to tame inflation (currently at 6.31% and close to the 6.5% ceiling of the nation's inflation-targeting band).

Fortunately, there is not that much tension looming on the unemployment front, which currently stands at 5.4%, the lowest level since March 2002.

The Brazilian currency is also strengthening, signaling the bullish growth prospects for the nation. The Brazilian Real is up 3.7% against the dollar so far in 2013, and recorded the biggest gain among 32 major currencies this year (read: Will Brazil ETFs Rebound in 2013?).

Furthermore, the economic sentiments are improving globally albeit at a slower pace. The country should also see a surge in construction and infrastructure spending as it prepares to host the 2014 World Cup and the 2016 Olympic Games. These could act as a new stimulus program for the nation and help to pull it out of the doldrums.

Thanks to this optimism, investors should focus on the ultra-popular–MSCI Brazil Index Fund (EWZ - ETF report), which tracks the MSCI Brazil 25/50 Index – to target the country. The product added 3% in the last three months, indicating a reversal in trend from the last three years, which were moderately in red.

Though this Brazil ETF lost around 0.38% year-to-date (as of March 15), it is leading the broader Latin American funds significantly.

The product has slightly outperformed the most popular funds targeting the region including the iShares Latin America 40 Index Fund (ILF - ETF report) by roughly 100 bps, iShares MSCI Emerging Markets Latin America Index Fund (EEML) by 30 bps, and other regional products by similar amounts as well.

This remarkable performance was aided by its holdings breakdown which is heavily skewed towards financial securities. The fund has nearly 28% of the assets in the sector, which is leading the overall market in 2013 owing to strong performances by the banking stocks (read: What is Driving Bank ETFs Higher?).

The ETF is also well spread across its 82 securities in the basket with less than 50% of the assets in top 10 holdings. Itau Unibanco (ITUB), Petrobras (PBR - Analyst Report) and Banco Bradesco (BBD) occupy the top three positions in the basket with 7.54%, 7.29% and 6.37% share, respectively.

PBR, which has been suffering in terms of earnings over the last two and half years, has recently made a smart move by raising diesel prices. This move could be the beginning of a change in the business and might fuel earnings growth prospects going forward for this important company.

For this reason, Credit Suisse has upgraded PBR to Outperform from Neutral. This news is also driving EWZ higher this month as PBR alone had gained 20.58% since the beginning of March.

The ETF focuses on the large cap segment that accounts for 84% of EWZ, while mid cap takes the remaining portion. In terms of style exposure, the product has a tilt towards growth stocks, ensuring higher returns to investors, especially in booming periods, as these offer above-average revenue and earnings growth with high price-to-book ratio.

Since the Brazilian economy is rebounding slowly, the growth fund seems like a logical choice for those expecting a return to market health in the second half of the year (read: The Best Investing Style ETF This Fiscal?).

Apart from fundamentals, let us have a technical look at the chart for the Brazil ETF and its trends:

From the above chart, EWZ is currently showing weakness on the price front as it is trading below the 9 EMA line and it has met the 50 EMA line. However, the fund is trading above the 200 EMA line, suggesting a possible trend reversal.

Additionally, the fund is trading near its resistance level of $56. Crossing this level will show a clear strong uptrend. It has also witnessed a bullish breakout accompanied by very high volumes of nearly 12.5 million shares per day on average.

Bottom Line

Thanks to its extreme liquidity, investors do not have to pay an additional cost beyond the expense ratio of 0.60%. The fund has an impressive asset base of $8.2 million, so trading should be quite easy in this product (see more ETFs in the Zacks ETF Center).

Given its fundamental, technical and economic outlook, investors with a high risk tolerance and desire for more income could find EWZ an interesting choice. The Brazilian economy is showing signs of improvement but is not expected to rebound at least by the second half of the year.

As a result, the overall outlook for Brazil is still neutral until and unless more positive data comes into the picture. Hence, we are maintaining our Zacks ETF Rank of 3 or ‘Hold’ on EWZ, but we think better news could be ahead for this Brazil ETF in 2013.

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