EWZS - EWZS: Just Small Enough To Fall Under The Populist Radar

Summary

• iShares MSCI Brazil Small-Cap ETF tracks an index of Brazilian small-cap stocks.
• Brazil has had a tumultuous year, both politically and economically.
• The re-election of former president and avowed populist Lula makes the future of Brazil murky at best.
• The fund bounces around like a pinball, up 15% over the last month, down 4% over three months, up 1% over the past year.
• Due to the extreme volatility of the fund, we rate it a Sell for the short term and a Hold for the longer term.

By Alex Rosen

Strategy

EWZS (EWZS) invests in a basket of Brazilian small-cap holdings. The index undergoes a quarterly rebalance and uses market capitalization to select and weigh its holdings. The fund chooses a sample strategy that is representative of the broader small-cap market in Brazil.

Proprietary ETF Grades

• Offense/Defense: Offense
• Segment: Non-U.S. Equity
• Sub-Segment: Latin America
• Risk (vs. S&P 500): Very High

Proprietary Technical Ratings*

• Short-Term (next 3 months): C
• Long-Term (next 12 months): C

* Our assessment of reward potential vs. risk taken

(Rating Scale: A=Excellent, B=Good, C=Fair D=Weak, F=Poor)

Holding Analysis

As a small-cap fund solely investing in Brazil, EWZS takes a broad sector view of the market. Utilities lead the way, accounting for almost 20% of the fund followed by Consumer Discretionary at 18%, Industrials at 16%, Materials at 11% and Consumer Staples at 10%.

Individually, the fund holds 110 unique stocks, led by Eneva, a utilities stock at 4.2%, Embraer (Industrials) at 4%, Metalurgica Gerdeau (Materials) at 3.6%, and 3R Petroleum (Energy) at 2.8%.

Strengths

Things are happening in Brazil. It is not a quiet time in Rio, or Brasilia, for that matter. In October of 2022, the Brazilians went to the polls and voted out the conservative incumbent Jair Bolsonaro and replaced him with Lula, a man of many stories. Lula was, for a long time, the left-wing voice of opposition in government, until he got elected president in 2003. He served until 2010, leading the country through a series of reforms, the biggest among them was Bolsa Familia , a conditional cash transfer program that rewarded low income families for doing things like sending kids to school, vaccinating children and working. Lula was beloved, but he also had his critics. After leaving office, he found himself in jail on charges of corruption . Fast forward to 2021, and he is out of jail and back in politics. Bolsonaro famously modeled himself after Donald Trump and proudly wore the title of Trump of the Tropics. The election between the Trump of the Tropics and the man of the people was not without controversy and even before election day, Bolsonaro stated that he would only accept the results if he won. He lost, and promptly left the country.

Since Lula was sworn in again, Brazil has had its own version of January 6th , where Bolsonaro supporters stormed the capital demanding the military invalidate the election. It did not happen. Lula has been sworn in and is beginning his new term in office. As a populist, Lula has long been a staunch supporter of small businesses and poverty reduction. As a result, it is highly likely that his government will pour money into the economy to prop up the smaller businesses.

Weaknesses

Up until February of 2022, Brazil was skating by as the third of four BRIC countries. Not as dysfunctional as Russia, not the global powerhouse that is China, but somewhere comfortably behind India. The joke in global forums is that Brazil is perennially the next big thing. However, potential is like some fruit on the vine. Eventually if you don't pick it, it will rot. How long is it before Brazil's potential turn to rot? When they hosted the World Cup and Olympics in 2014 and 2016 respectively, it seemed as if Brazil had arrived, but since then, they went right back to floundering. The country is no better off today than it was 50 years ago. Inconsistent growth has seen boom and bust cycles repeat over and over again.

Opportunities

The highlights are a new government, and a new scheme to reduce poverty and stabilize the economy. Lula may continue the policies that made him such a beloved man of the people. The program showed a net gain in GDP of 0.78 %, and it aided the highest risk segment of the population, leading to stability and a reduction in crime. A repeat of this will certainly be good for the small-cap sector of Brazil.

Threats

Look at the chart of Brazil's GDP growth. It is very similar to the returns of EWZS. A real roller coaster of a ride. One minute you're riding high, the next minute you are calling the IMF asking for a bailout. Sustainability and Brazil do not go hand in hand. This is scary considering the preservation of the Brazilian rainforest is one of the most critical factors for global sustainability.

Conclusions

ETF Quality Opinion

Emerging market funds by nature have a high degree of volatility. Small cap stocks are more susceptible to market shocks, and then Brazil is a whole other wild ride. The model is sound, take a representative index of small-cap stocks along a broad range of sectors. Nothing fancy, plain vanilla. If this were in, say, China, or South Korea, we would have a totally different outlook, but it's not. It's Brazil.

ETF Investment Opinion

This is not a fund for the faint of heart. If you want to invest in this fund, you should also consider investing in Maalox or Tums. If you are holding it, now might be a good time to get out. The fund is simply too volatile for our tastes, and as result we rate it a Sell.

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