Brazilian brokers negotiate at the Brazilian Mercantile and Future Exchange, in Sao Paulo, Brazil.
If harried American investors are considering the old adage "Sell in May and go away," Brazil might prove a sunnier destination.
Ratings agency Standard & Poor's upgraded Brazil to investment grade last week, and shares promptly surged thanks to the earlier-than-expected bump. The iShares MSCI Brazil Index, an exchange-traded fund that tracks Brazil's Bovespa index, rallied 8 percent on the day of the announcement and continues to climb this week.
Brazil's ability to buck trends is a reward for smart stewardship of huge profits the country has made in the ongoing global commodities boom. Surging prices, from oil and metals to coffee and grains, prompted interest from investors, while central bankers have kept inflation largely in check and domestic growth on track.
As a result, Brazil's economy is more stable than it's been in nearly two decades. Gross domestic product grew 5.7 percent last year, up from 3.7 percent in 2006, and public debt as a percentage of GDP has been shrinking for five years. Brazilian stocks jumped 70 percent in the past year, while other hot emerging markets like China and India watched equities slump mightily.
Geoffrey Dennis, Citigroup's Latin American strategist, says the upgrade is a credit to meaningful improvement in Brazil, and he sees a bit more upside in shares this year.
"This boom in commodities prices worldwide has been very beneficial for Brazil, but at the same time they've used the bounty of commodity prices extremely wisely. They've built up reserves and followed very tight monetary policy to bring inflation down into the single digits. You're talking about tremendous macro improvement," he says.
Dennis raised his target for Brazilian shares after the upgrade and sees the Bovespa index ending the year around 74,000 after heading above 70,000 on Monday.
Raw materials remain central to any Brazilian investing story, he says. Cyclical stocks—materials, energy, and the like—make up some 60 percent of the Bovespa and remain the best place to invest after the upgrade.
Dennis listed a few favorites among big-name Brazilian stocks available on U.S. markets:
Mining giant Vale, formally known as Companhia Vale do Rio Doce, remains a top pick.
"It's a tremendous earnings machine right now with the rising price of metals and close links to China. It does depend on what happens to the currency and the dollar in the short term," Dennis says.
Vale is the world's largest producer of iron ore, which is used in steel production. There, sales volumes rose 15 percent year-over-year as demand increased at home and continued to grow in China.
Aracruz Celulose, a giant pulp and paper maker, is hitting new highs, too.
"It's basically one of the world's cheapest pulp producers, if not the cheapest," Dennis says.
Aracruz's first-quarter net profit rose 17.5 percent to $116.9 million, or $1.13 per American-listed share, up 97 cents from a year earlier. Analysts expect results to improve further this year, despite rising production costs.
Banco Itau. "We like the banking sector even though interest rates are rising in Brazil again," Dennis says. "It's a little bit of a negative, but all of this in terms of the investment grade [rating] benefits the economy."
Already, Bloomberg is reporting that Brazilian banks are offering longer-dated bonds as a result of the upgrade.
Aircraft maker Embraer is what Dennis calls a "slightly more controversial pick." Its shares are down more than 11 percent year-over-year despite Brazil's rally.
"Its stock has done less well lately as people worry it's a name that's vulnerable to a big global slowdown, which we're not anticipating. It's a name we think will ride through what's left of that slowdown," he says.
Embraer has surprised analysts recently as demand for its smaller planes heats up among non-U.S. customers. First-quarter results were mixed. Healthy aircraft deliveries and a big 58 percent jump in revenue failed to boost earnings of 46 cents a share. That was below Wall Street forecasts of 54 cents, as the rising value of Brazil's currency, the real, cut into profits.
Risks remain, however. The S&P upgrade will most likely mean an even higher value for the real, which could crimp profits at some of the exporters listed above, although global growth will continue to support better names.
Two other trends could derail Brazilian shares: an end to the commodity boom and, oddly, a return to health for the U.S. economy. The two are intertwined.
"This is a significant complication," Dennis says. "Commodity prices will come down sharply when the U.S. economy starts to recover." If that seems counterintuitive, the answer is to be found in the dollar. A U.S. recovery, and the stronger greenback that would accompany it, could spell the end of the speculative fervor in commodity markets. Basically, if the greenback reverses its downtrend, Brazilian shares could weaken.
Also, analysis of past S&P upgrades shows that shares often fall following an investment-grade bump. Other nations like Mexico and Russia saw declines in the months following their upgrades. Still, Brazil's boost came earlier than expected, and that could help minimize some of the post-party hangover.
Uncertainty aside, the events of the past week mark a heady achievement for Brazil. It will be worth watching for some time to come.
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