Brazil may be one of the top-performing emerging markets in the coming years. I have been monitoring Brazil for a wide number of reasons and think now might be a solid entry point. Brazil’s economy will benefit from an increase in commodity prices and is arguably more stable than some of its Latin American peers such as Colombia and Brazil. Brazil is also very appealing because it offers more ADRs for US investors. The newest development that has caught my attention has been the events unfolding in Russia, which will make Russia be off the radar for many emerging market investors. Brazil could fill in this gap some of this gap in my opinion.
Most emerging market investors are well aware of the acronym BRICs, used to describe the emerging markets of Brazil, Russia, India, China, and South Africa. Brazil is positioned in a sweet spot in my opinion, in terms of macroeconomics and demographics.
With Russia potential out of the picture, Brazil stands out as a significant global economy, coupled with some of the desirable characteristics seen in other emerging markets. A relatively low GDP per capita, coupled with favorable demographics, makes Brazil positioned to be a desirable target for emerging market investors.
There are two factors in the near future, which could help catalyze the realization of Brazil’s full potential. Those two events are the introduction of a bull market in commodities, which we are certainly seeing, as well as a potential for MSCI to increase Brazil’s weighting in the MSCI Emerging Markets Index.
Brazil’s export structure is a paradise for investors bullish on commodities. Its top 5 exports include soybeans, crude oil, iron ore, cellulose, and corn. If you continue down the list, the story is roughly the same; commodities and food. The diversification of the mix is interesting, as bets on countries such as Chile, Peru, and Colombia for example largely hinge upon the performance of a single particular commodity, such as copper or oil. Food security may become an increasingly significant theme during the next two years, as seen when countries such as Thailand and Vietnam prepared to restrict rice exports in the 2020s amid covid.
Unfortunately, MSCI is a big driver of what ends up happening in these equity markets. Argentina’s larger weighting in its index caused an irrational rise in equities during 2018, despite poor economic fundamentals. So a stable macro picture and more favorable growth prospects driven by a commodity boom are not enough. I am early in this call, and would most certainly need to hear more announcements from MSCI, but I think it is extremely reasonable to suggest that Brazil’s weighting in MSCI Emerging Markets has a lot of room to increase.
Brazil is currently ranked number 5 in this mix, and quite frankly the weighting of the top 4 markets is way too large. One could argue that the geopolitical risk associated with China and Taiwan, may cause outflows from these markets in the coming years. What is clear is that a 31.76% weighting is way too large and that a lot of active emerging market investors are well incentivized to ignore this and go underweight China and overweight Brazil as they see fit. Could the exit of Russia, with a 1.5% weighting, have a significant impact on Brazil? I would say that Brazil can benefit slightly, maybe absorbing 20% of this or so, but some of the smaller off-the-radar emerging markets would obviously benefit more. I have my eye on Pakistan and Egypt for this very reason. Where I think Brazil truly wins is when it begins to receive overweight allocations from other investors.
I am not long Brazil at the moment but am actively eyeing the market. I think I will take the opportunity to accumulate positions between now and the election in October if the price is right. After October, I will likely increase my exposure if things look stable. Brazil would represent well over 5% of my emerging market portfolio. I would not have this level of confidence to bet on Chile or Colombia.