EWZ - Carnival in Rio, Carnival in Markets?

[The_Ni]

Tl;dr Bullish on Brazil ETF, EWZ, because rate cuts are likely coming as inflation cools.

Carnival in Rio is going to take place in Rio in Feb 2024. There’s a good chance we might see excitement in the Brazilian stock market by that time too.

Here’s the train of thought behind being bullish on EWZ:

1. Brazil’s markets are doing quite well, after the Lula election scare. (barchart in image below)
2. Brazil started the year with high inflation, but has been able to bring that down recently. (YoY is teal, MoM is orange)
3. This has largely been due to their interbank rate, Selic, being at 13.75%, and holding (yellow line)
4. We know when lending rates fall, markets moon. There is chatter of the Selic being cut as soon as August. And next meeting is early Aug.

We have see this play out 7 years ago, when markets went up ~40%:

Two confounding macro factors to this:

• The Brazilian Real (BRL) appreciating depresses the EWZ, and depreciating makes it go up. It is depreciating right now, so working in favor of this play. I know f*ck all about BRL, so won’t guess where it’s going in the future, though will note that as interest rates go down, currencies tend to fall, so feel like the core thesis is bullish with regard to BRL.
• A significant chunk of Brazil’s GDP, and fate of listed companies, is tied to commodities. That’s been working out well for Brazil so far, but if there is a global recession, this could hurt EWZ a bit. Long term though, there usually is a commodity upcycle on the other side of recession, so eventually this should be bullish.

And one option-based encouragiing sign - folks bought up a brickton of calls for Aug 18, along with 25K puts that are likely a hedge:

Incidentally, EWZ also pays a decent 8-9% dividend, based on recent returns.

This does cause some overlap with PBR, which I’ve been playing separately, but will ignore that for now

Finally, may hedge a bit of this with 18th Aug puts in case stock falls to $30, which will where I’ll have the stop.

[The_Ni]

Grabbed the following in anticipation of a bullish move over the next months:

• Commons for $32.25
• Handful of 8/18 (44DTE) 35C/36C bullish call spreads for $0.20 in case market responds really well to any rate cuts, or in anticipation thereof

And these as hedges:

• 8/18 (44DTE) 31P/30P bearish put spreads for $0.22 - enough to recover what I would lose if the commons get to the stop of $30.

Needless to say, one of the call or put spreads will expire worthless. Here’s to it not being both!

[The_Ni]

A reminder that Brazil’s Central Bank meeets on Aug 1 and 2 to decide if there will be a rate cut.

The general expectation is of a 25-50bps cut from the current 13.75%:

A Genial/Quaest poll of 94 fund managers, economists and analysts working for 67 different firms in Brazil showed earlier this week that 92% of them forecast the central bank to kick off a monetary easing money cycle next month. However, they still diverge on the size of the cut, with 55% of those polled betting on a 25 basis point move while 32% expect a 50 basis point cut.

(Source)

The play is: rates go down, Brazilian stonks go up.

Fwiw, EWZ has barely moved and is 3% up from I opened positions almost a month ago. And ofc, because the option gods hate me, the current price is precisely between the $31 & $35 strikes of my long legs; at this point not expecting salvation in the remaining 18DTE.

Edit: Some additional context - rate cuts will not be super sharp. This makes this a potentially year-long play.

Long-term inflation expectations, which have been an explicit concern for the central bank, have fallen since the government decided to keep its annual inflation target at 3% for the coming years. Lula had previously called for higher targets, allowing for looser monetary policy.

Consumer inflation in the 12 months to mid-July slowed to 3.19%, falling short of market projections and dipping below the central bank’s official target of 3.25% for this year, although an uptick is expected due to less favorable baseline effects.

Progress in Congress on new fiscal rules and tax reform have also spurred credit rating agency Fitch to raise Brazil’s sovereign credit rating this week, resulting in the country’s five-year Credit Default Swap (CDS) reaching its lowest level in more than two years .

“There would be conditions for a more aggressive rate cut in August, but the central bank, somewhat divided within its board, is likely to opt for a 25-basis-point reduction,” said Julio Hegedus Netto, chief economist at Mirae Asset.

The bank’s August meeting will be the first to include two of Lula’s nominees to the board. The remaining seven members, including governor Roberto Campos Neto, were chosen by former President Jair Bolsonaro.

All 35 economists who answered an additional question in the poll predicted another rate cut in September, with over 85% betting on a 50-basis-point reduction.

For the end of 2023, the median expectation of 36 respondents is for a benchmark interest rate of 12.00%, and by the end of next year the median projection of 30 economists is for the rate to drop to 9.25%.

[The_Ni]

Topped up on EWZ, picked up STNE @ $13.71 and PAGS @ $10.49 on their rather sizeable pullbacks today. The large drop today is curious, but am not seeing any news. We should get news on rate cuts by end of day today.

[The_Ni]

Brazil CB cut rates by 50bps, from 13.75% to 13.25%, and indicated it’ll keep cutting.

Brazil’s central bank cut its benchmark interest rate by half a percentage point, the first change to the rate in a year, and said it could be the first of a series of cuts meant to substantially reduce one of the world’s highest interest rates.

The bank’s monetary policy committee, or Copom, reduced its key Selic rate to 13.25% from 13.75%, after raising it to that level in August 2022. The move reverses a rate-increase cycle launched in March 2021 when the Selic was at a record low of 2%.

The bank said it considered cutting the Selic by a quarter-point, but chose to make a larger cut because of continuing improvement in the country’s inflation outlook.

“If the scenario evolves as expected, the committee members unanimously anticipate further reductions of the same magnitude in the next meetings, and it judges that this pace is appropriate to keep the necessary contractionary monetary policy for the disinflationary process,” the Central Bank of Brazil said in a statement.

[The_Ni]

@The_Ni

8/18 (44DTE) 31P/30P bearish put spreads for $0.22 - enough to recover what I would lose if the commons get to the stop of $30.

Sold these for $0.45. But! Note that there was the paired call spread for $0.20 also, and that expired worthless. Net-net, this was a break even play. Wild that this is where it ended up 6 weeks after I opened the positions. It’s almost like markets are too efficient, or something

On the overall Brazil trade, things don’t look that great at the moment. My positions:

• EWZ down 6%
• STNE down 8%
• PAGS down 16%

While part of this correction seems to be a sell-the-news event around the CB lowering of interest rates, the depreciating Brazilian real is not helping either. On a currency adjusted basis, EWZ is down 2%.

Also, big picture, seems like inflation isn’t quite staying low though, showing a surprising rebound in July:

The annual inflation rate in Brazil jumped to 3.99% in July of 2023, sharply rebounding from the near-three-year low of 3.16% in the previous month and firmly above market expectations of 3.93%, moving above the BCB’s target of 3.25%. The result halted twelve consecutive months of slowing inflation in the Brazilian economy, raising doubts on whether the Brazilian central bank will resume cutting interest rates at the fast pace from the last meeting. Inflation rebounded for transportation (0.25% vs -5.68%), as gasoline deflation slowed considerably (-10.66% vs -26.35% in June) after the central government reinstated fuel taxes. Inflation also edged higher for housing and utilities (4.37% vs 4.32%) amid higher electricity bills (3.2% vs 1.18%). On the other hand, inflation slowed for food and non-alcoholic beverages (2.2% vs 4.01%). On a monthly basis, the IPCA index edged 0.12% higher, rebounding from the 0.08% decline in the previous period.

This might complicate this play and require longer to play out, as it is possible that the CB will not lower rates in the next meeting. The big picture thesis still holds though, so I’m holding too.

[The_Ni]

Inflation continues to be stickier in Brazil, delaying the reduction in interest rates that this play depends on:

The annual inflation rate in Brazil increased to 5.19% in September of 2023 from 4.61% in the previous month, the highest in seven months, but below market estimates of 5.27%. The result extended the departure from the Brazilian government’s target of 3.25%, backing some expectations that the central bank’s current cutting cycle may be softer than expected. Consumer prices accelerated considerably for transportation (7.7% vs 4.1% in August), largely due to high fuel costs (13.42% vs 1.05%, amid easing base effects from the Russian invasion of Ukraine, a fresh surge in crude oil prices across the world, and elevated costs of ethanol in Brazil’s main sources. On the other hand, inflation continued to slow for food (0.88% vs 1.08%), amid reports of strong agricultural harvests, and housing and utilities (5.28% vs 5.42%). On a monthly basis, consumer prices edged 0.26% higher.

As of now:

• EWZ down 7%
• STNE down 25%
• PAGS down 28%

Will likely top up on PAGS tomm since it’s at the bottom of its 1Y range. No actual bad news, though there were a few downgrades. I don’t mind if it goes lower as the company seems solid.

Won’t top up on STNE just yet - have buy orders for $8.50 in place.

I have no doubt that Brazil stocks are still cheap, and that this is a waiting game. We can see the relative value of Brazilian stocks here:

[The_Ni]

Brazil Central Bank cut their benchmark rate again yesterday:

As expected, shares popped:

PAGS and STNE still lagging, but with expectations of the rate going down to the 8-handle by the end of 2024, there’s still a lot of room to grow into. Especially as debt gets refinanced, and interest expenses go down.

[The_Ni]

Since the interest rate cuts, EWZ is up 16%, PAGS is up 36%, and STNE is up 47%. (Strong results from PAGS and STNE also helped.)

I don’t plan on adding anymore as am fully allocated to the three tickers, but I do think there’s much more of this play left, and it’s quite possible we have some pullback after this rally, especially as the currency fluctuates.

[The_Ni]

A post on TF made me realize I hadn’t updated this thread in a bit. Current status over last 6 months of holding:

• EWZ up 2% (basically flat)
• STNE up 29%
• PAGS up 33%
• PBR up 62% (this is an energy play as much as it is a Brazil play, so two catalysts)

As you can see from the graph below, I was clearly early in Aug, and Nov would have been a better time to get in. I did double down on STNE and PAGS around then. The thesis still holds, as Brazilian interest rates are coming down slowly, but slooooooowly.

[Fllwoman]

In other Brazil news, Gol (one of the 3 major airlines there) is contemplating Ch 11 bankruptcy. The airline has been a disaster for years. Every couple years they ask their lessors and vendors for relief. It’s probably reached the point where those folks have said no more.

[Fllwoman]

Brazil's Gol airlines files for Chapter 11 bankruptcy (NYSE:GOL)

[The_Ni]

Brazilian markets have remained largely flat over the last few months, but the USD has strengthened, causing a drop in EWZ and other stocks. The underlying thesis still holds, as YoY inflation keeps coming down, and so does their SELIC rate in response. If anything, this is a nice setup for additional tailwind when the USD is not as strong again.

I have added a started position for VALE to my portfolio last week at 12. It is in the lower part of a nice wedge it’s respected for a while. It mines iron ore, nickel, copper etc - things that are all out of favor at the moment, but which have a long term structural deficit. This, like PBR (and unlike the tech) are long, long term holds.

EWZ - -5%
PAGS - 19%
PBR.A - 63%
STNE - 13%