Maybe Dilma is not that bad. Ok, that last comment is ridiculous. Dilma Rousseff, Brazil’s reelected president is horrible, one of the worst national leaders in the Americas, in fact. She has micromanaged the Brazilian economy and killed the country’s growth in the process. She has also eroded the independence of the central bank and stoked high inflation in the process. The worst of it is she has scared much-needed capital, both foreign and domestic, out of Brazil. But there comes a point when even the potentially disastrous policies of a heavy-handed dirigiste administration (centralized authority) with no respect for the free market are fully priced in, and that’s roughly where Brazil is today.
Take a look at the chart above. After multiple years of disappointing returns, Brazilian stocks had a fantastic run from February to early September of this year, due, at least in part, to a belief that Dilma would lose the presidential election earlier this month. When the polls started suggesting a Dilma win, Brazilian stocks went into a tailspin and continued to drop immediately after she won the election.
But then, a funny thing happened. Brazilian stocks jumped on Thursday, up over 4% on the day.
What happened?
A couple things happened. First, Brazil’s central bank raised interest rates. Normally, that would be bad for the market, but, in the case of Brazil, it showed a pronounced change of direction by Dilma. She’s staying out of the central bank’s affairs and allowing it to do its job of fighting inflation. This is a return to normal, orthodox monetary policy — policy that makes investors comfortable. Since her election, Dilma has also made conciliatory gestures toward business, including promising to replace finance minister Guido Mantega, a finance minister Wall Street particularly dislikes.
In my view, though, the biggest reason for the jump in Brazilian stocks is, simply, all the bad news is more than priced in. Brazilian stocks trade at a CAPE of just 10 and have been in a bear market for four years now. Investor sentiment towards Dilma is so bad that it is hard to see it getting much worse. If she proves to be even marginally less than horrible in her second term, investors might be in for a pleasant surprise.
Action to take: Buy shares of EWZ and plan to hold for 2 years or more for what I expect to be total returns well in excess of 100%. Use a 25% trailing stop as risk management.
For more informaion on this trade or others, please visit me.
