More Bad News For Brazil ETFs

At a time when the iShares MSCI Brazil Capped Index Fund EWZ and other ETFs tracking Latin America's largest economy can handle no more bad news comes this.

Citigroup has slashed its year-end target for Brazil's benchmark Bovespa index to 65,000 from 70,000. The bank cited slack economic growth and rising inflation, according to Bloomberg.

The Bovespa, which is down more than 10 percent year-to-date and nearly 15 percent in the past year, currently trades around 55,560 so it can be said the Citi forecast is still somewhat bullish.

Indeed, the two largest Brazil-specific ETFs have outperformed the Bovespa this year, though that is not saying much. EWZ, the largest by assets of Brazil ETFs, is down 4.6 percent year-to-date. The Market Vectors Brazil Small-Cap ETF BRF is lower by seven percent.

EWZ's performance is also a tad better than the 5.5 percent loss posted by the Vanguard FTSE Emerging Markets ETF VWO.

Still, it is fair to say Brazil ETFs have had ample headwinds with which to contend this year.

EWZ is home to 82 stocks, but two loom larger than all others: Petrobras PBR and Vale VALE.

Shares of Petrobras, Brazil's state-run oil giant, are off 17.2 percent this year, but rivals Exxon Mobil XOM and Chevron CVX have both traded noticeably higher. Then there is Vale, the world's largest iron ore producer.

Wilting under the clouds of slack global materials demand and faltering iron ore prices, Vale's U.S. shares are lower by more than 21 percent this year. Petrobras and Vale combine for 21.8 percent of EWZ's weight.

Barring a significant turnaround in those stocks, Citi's forecast of 65,000 for the Bovespa by year-end seems ambitious. Round the Bovespa's current level up to 55,600 and it would still take a gain of nearly 17 percent to reach 65,000.

With the materials sector showing obvious signs of weakness, forecasting a significant rally for EWZ becomes tricky as that ETF allocates 16.7 percent of its weight to materials names.

Factoring domestic inflation into the equation means an even murkier outlook for BRF and EWZ in terms of potential upside. EWZ allocates about 20 percent of its weight consumer-oriented shares. Alone, discretionary names account for 34 percent of BRF's weight, according to Van Eck data.

Brazil ETF bulls should watch for two things: EWZ's ability to hold support around $52.50 and whether the ProShares UltraShort MSCI Brazil BZQ moves above $70. In the case of BZQ, the move above $70 could bring new buyers into the thinly-traded, double-leveraged bearish Brazil play.

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