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Brazil Recession Worsens: Time to Buy ETFs on the Slump?

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Economic woes are not new to the Brazilian economy with its gross domestic product shrinking for the eighth successive quarter. Brazil recorded a 0.9% sequential decline in GDP in the fourth quarter of 2016, reflecting the steepest slump in a year after a revised 0.7% drop in the previous quarter and wider than market expectations of a 0.6% fall.

With this, the Brazilian economy saw two straight years of recession in 2016. On a yearly basis, Brazil's GDP plummeted 3.6% in 2016, following a 3.8% slump in 2015. Investment declined 10.2% last year, probably reflecting Brazil’s high interest rates. Household consumption was also in bad shape (read: Brazil ETFs Are Piping Hot: Time to Buy?).

How Should the Investing World React?

Brazilian stocks and ETFs have been on a tear this year with the large-cap Brazil fund iShares MSCI Brazil Capped (EWZ - Free Report) advancing about 13.8% and the small-cap fundiShares MSCI Brazil Small-Cap (EWZS - Free Report) surging about 30.2% (as of March 7, 2017).

The reason for this was successive rate cuts by the Brazilian central bank. Hopes of new reforms that can shore up the country’s recession-stricken economy after the impeachment of president Dilma Rousseff, commodity strength and easing inflationary pressure perked up Brazil ETFs(read: 4 Best Single-Country ETFs of 2016).           

In view of cooling inflation (which was once sky-high) and soft economic growth, Brazil embarked on an aggressive policy easing cycle. The country slashed interest rates by 25 bps for the first time in four years in mid-October, giving signs of a turnaround in the long-ailing economy.

The Brazilian central bank cut rates by 25 bps in November, by 75 basis points to 13.00% in early January and by 75 basis points to 12.25% in late February. The fourth rate cut pushed down borrowing costs to almost a two-year low.

Now, the recently released weak GDP data has stirred talk of further and steeper rate cuts in the coming days. And rate cuts are possible given the fact that the inflation rate declined for the fifth month to 5.35% in January, reflecting the lowest level since September of 2012. Low rates would provide some relief to debt-ridden families and perk up business sentiments (read: Top ETF Stories of January 2017).

Has Brazil Recession Bottomed?

A group of analysts believe that Brazil is now showing signs of recovery. Some expect the economy to log a meagre 0.5% expansion in 2017, though the government had forecast 1%. However, responding to the weak GDP data, some economists lowered their view on the economy and see no growth. In fact, they believe that anything meaningful on the positive side is not expected before 2018.

Note that, President Temer is trying to clear an austerity agenda through Congress. Finance Minister Henrique Meirelles said, “the government could raise taxes or cut spending further if necessary to achieve its 143.1 billion reais ($45.87 billion) primary deficit goal.”

Finance minister of Brazil also indicated that the latest GDP data bore the mistakes of past policies. Market watchers now believe that this could be the end of recession and the economy will take root, but slowly. So, moderate gains are likely ahead. If the greenback starts to rise rapidly on Fed’s policy tightening, Brazil ETFs may see some troubles.

EWZ has a Zacks ETF Rank #3 (Hold) and a positive weighted alpha of 43.10. Zacks Rank #3 EWZS has a positive weighed alpha of 73.50 and VanEck Vectors Brazil Small-Cap ETF (BRF - Free Report) has a positive weighed alpha of 63.40. Since positive weighed alpha hints at more gains, investors can play the funds a bit more (see all Latin American Equity ETFs here).

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