Next Week Could Be Huge For Brazil ETFs

After being a major drag on emerging markets exchange traded funds over the past couple of years, Brazilian stocks are reversing that trend in a big way. The iShares MSCI Brazil Capped ETF EWZ, the largest ETF tracking stocks in Latin America's biggest economy, is up more than 38 percent this year.

If EWZ's resurgence were described in recipe terms, it would be one part rebounding commodities prices and one part intensifying speculation that Brazilian President Dilma Rousseff will be impeached. Recently, a Brazilian congressional committee voted to do just that and there is a good chance the lower house of Brazil's congress approves an impeachment on Sunday.

“The tide within [Brazil's] centrist parties seems to be shifting more in favor of impeachment given the recent developments in [the corruption investigation] Lava Jato and the prosecutor’s decision to recommend [former president] Lula not be a minister. All in all, we remain of the view there is a 60% probability the lower house of congress approves a motion for impeachment this Sunday, April 17,” according to a Eurasia Group note posted by Barron's.

Previously, a problem for EWZ was weakness in Brazilian bank stocks, which is particularly problematic when considering the sector's issues against the backdrop of some of the developing world's highest interest rates. EWZ's financial services weight is about 36.5 percent, or more than double the ETF's second-largest sector allocation, consumer staples.

However, that sector has been a pleasant surprise to investors. After all, it would be virtually impossible for EWZ to rise 38 percent if over 36 percent of its lineup was not participating. Itau Unibanco ITUB and Banco Bradesco BBD, two banks found in EWZ's top 10 lineup, are up 47.5 percent and 70.8 percent, respectively, this year.

All of this against a backdrop of some of the highest interest rates in the developing world and contracting economic activity. In fact, Brazil's GDP is expected falter by 3.4 percent this year. Even after a major run higher, Brazilian stocks, which are often richly valued relative to broader emerging markets benchmarks, offer value in the eyes of some.

“Much of the bad news about Brazil appears already priced into the market. Brazilian equities, as measured by the MSCI Brazil Index, are 20 percent cheaper than their 2014 highs on a price to book basis. This means we could see Brazilian stocks move higher if confidence in the market is restored,” according to BlackRock.