Brazilian Stocks

 Brazilian Stocks: The Caipirinha Connection
by Eric J. Fry
The Rude Awakening
Wall Street, New York
October 11, 2004

Eric Fry recounts a discussion he had wit ha stockbroker on the oil sector and Brazilian Stocks.

"...a bet on Brazilian stocks is not merely a backdoor play on the oil sector; it is also a backdoor play on Chinese economic growth."

--------------------------------------------------------------------------------

"I just can't pay up for this stuff," a successful stockbroker griped yesterday. "I should have been in all these energy stocks months ago, but every time I thought about pulling the trigger, they were running away from me again...and they just kept running."

"Yeah, it's always that way during a bona fide bull market," your editor replied. "You're always chasing it and you never own enough."

"Until it reverses," the broker replied, "and then you own too much."

"Ahhh...the voice of experience."

"Not owning these stocks is bad enough," the broker continued. "But if I jump in now and top-tick these stocks, my clients would remind me about it for years. I guess I could buy Exxon or something like that...ya know, it would participate if oil keeps rising, it pays a 2% dividend and no client will complain about owning it if it doesn't go up right away...But that seems like a cop out to me."

"I hear ya."

"It's not like I missed the oil rally altogether," said the broker. "I just didn't buy very many DIRECT plays. But I own a few different IN-direct plays on the oil market. They've been doing great...and I'm happy to keep buying some of these. Have you looked at 'EWZ,' the ETF for Brazil?"

"No, but I've been a big fan of Brazilian stocks for the last several months...and I've started drinking Caipirinhas regularly."

"Yeah, whatever...the point is that oil and resource stocks are the biggest components of EWZ. In other words, EWZ is a kind of back door into the oil and resource sector, and an inexpensive back door at that. Brazil's resource stocks, even though they are world-class competitors, sell for much lower valuations than their global peers."

"Hmmm..." your editor replied. "Let's take a look."

After tickling a few keys on his nearby Bloomberg keyboard, your editor found the page he was seeking. "Sure enough," he said, "Petrobras [Brazil's giant oil company] represents 25% of EWZ, while mining stocks like CVRD represent another 25%."

"You've also got the currency going for you," the broker continued. "I know it seems counter-intuitive to most folks, but Brazil's currency is not a bad one to hold right now. The Brazilian real, like all other 'resource currencies' in the world, benefits greatly from the commodity price boom."

"You're preaching to the choir, my friend," your editor replied. "Why don't you go call one of your clients and tell 'em all about it? Now that I've got my material for tomorrow's column, I don't need you anymore. See ya."

"You're welcome...sort of."

Brazilian Stocks: Not the Only Game in Town

EWZ is not the only game in town, dear reader. Two closed-end Brazil funds trade on the NYSE: the Brazilian Equity Fund (BZL) and Brazil Fund (BZF). Like EWZ, BZL also holds a hefty 25% position in oil and gas stocks (mostly Petrobras) and 25% in mining stocks. BZF, on the other hand, devotes only 14% of the fund to oil and gas and 24% to mining.

Remember too, that a bet on Brazilian stocks is not merely a backdoor play on the oil sector; it is also a backdoor play on Chinese economic growth. Brazilian exports to China have nearly doubled over the last three years, and the Asian juggernaut will likely overtake Argentina this year as Brazil's number two trading partner, remaining only behind the United States.

Thanks largely to booming Chinese demand for iron ore and other raw materials, CVRD's net exports alone represent a stunning 14% of Brazil's growing trade surplus with the rest of the world.

Both BZL and BZF trade about 10% below net asset value (NAV), a common, and attractive, feature of closed end funds. In other words, a buyer of either one of these funds spends only 90 cents to own $1.00 worth of assets. Think of it as "free leverage."

The Brazilian real has jumped nearly 25% against the dollar since the end of 2002, right in line with the Canadian dollar's 25% gain over the same time frame. The real has gained more than 8% over the last three months alone - the best performance among the world's 16 major currencies.

The Brazilian currency's newfound strength is not entirely a mystery. Brazil's budget deficit dropped sharply in August to the equivalent of 2.8% of GDP from 3.3% of GDP, and the country is on track to post budget surpluses by 2006. (Meanwhile, up here in the "developed" world, the United States has developed an unparalleled aptitude for running up massive deficits. Our twin deficits - budget and trade - both top 5% of GDP).

The Brazilian economy is roaring ahead at better than 5% annual growth and, not surprisingly, investment capital is pouring into the former investment pariah. Despite the country's stellar growth prospects, however, the Brazilian Bovespa Index sells for 12 times earnings and yields 4.6%, that's about half and twice the respective PE and dividend yield of U.S. stocks.

Lest we forget to mention it, Brazilian stocks, like most emerging market stocks, often subject their owners to volatile ups and downs. But as long as the successive "ups" are higher than the preceding ups, the "downs" are well worth enduring.

May we show you to the back door?

--------------------------------------------------------------------------------

Advertisement

--------------------------------------------------------------------------------

Did You Notice...?

 "The only difference between a caprice and a lifelong passion," Oscar Wilde once suggested, "is that the caprice last longer." Perhaps no caprice has lasted longer than America's passion for debt-financed consumption. And our capriciousness has become the mother of invention - from 0% car loans to interest-only home loans, we continuously invent new ways to advance and augment consumption, while deferring satisfaction.

Alas, our financial ingenuity cannot insulate us from $50 oil. Our wizardry can work wonders, perhaps, but not miracles. So now we find ourselves face to face with soaring energy bills - a cold, hard fact that forces a cold, hard response: a cutback in discretionary spending. The specialty retailers are already beginning to feel the adverse effects of a petroleum-induced frugality. The Gap's same-store sales for September dropped 3%, compared to a gain of 13% in September 2003. Several other retailers also logged disappointing sales for the month...

Watch this space.

--------------------------------------------------------------------------------

And the Markets...