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Brazil Stocks, ETFs Ignore Slump: Rally On Rousseff Issues

Recession is not new to the Brazilian economy as for the last three quarters the economy has not shown any growth. The Brazilian economy contracted 1.7% in the third quarter of this year, preceded by 2.1% GDP decline in Q2 and 0.7% contraction in Q1. The persistent decline flared up the country’s worst recession in 25 years . Year over year, GDP is off 4.5%. In the first nine months of 2015, the Brazilian economy shortened 3.2%, the largest decline ever, per trading economics . Investment declined for the ninth successive quarter and household spending dropped for the third straight quarter, making the recession acute. A persistent slump in commodity prices has badly hit the commodity-rich Brazilian economy. If this was not enough, China – one of the key trading partners of Brazil – is suffering from a prolonged manufacturing slowdown leading to further woes in Brazilian exports. This once-growing emerging nation – a pillar of the BRIC bloc – has been buckling under dual pressure of slower growth and heightened inflation for long. Inflation in Brazil reached a 12-year high in October and hovered around the 10% level – way above the central bank’s target of 6.5%. The Brazilian currency is down over 30% against the greenback so far this year and is likely to head toward decline once the Fed shoots the lift-off this month. The budget deficit widened the most in at least two decade. Joblessness soared to 8.9% in Brazil during Q3, up from 6.8% a year ago. This left consumers cash-parched and the household spending was down 4.5% in the quarter. Political corruption is also rampant in Brazil. The key interest rate at Brazil is at a nine-year high of 14.25%. In addition, a stagflation-like situation (where measures adopted to tame inflation will halt growth and vice versa) is prohibiting the central bank to hike the rate further to contain inflation. All in all, things are so chaotic, both at home and outside, that any easy way out of this vicious cycle of recession appears impossible. Is There Any Hope for the Market? Quite expectedly, the outrageous economic backdrop called for impeachment proceedings against President Dilma Rousseff on December 2. Charges against her include the violation of Brazil’s fiscal laws and the mishandling of government finances to pursue her re-election campaign in 2014, as per the Capital Economics report. Since Dilma Rousseff’s public support rating is now at record-low, Brazilian stocks rose on December 2. Since last year, we have seen that any news against Rousseff turns out favorable for the stocks as her administration is known to implement excessive red tape in the private sector. The investing world is now betting on an expulsion of the president, though this will take months if it all materializes. Moreover, UBS analysts commented that the political surroundings could be better off in 2016 to promote growth-oriented reforms and hence took a neutral stance on Brazilian stocks and sovereign debt (despite Brazil’s credit rating was slashed to junk in September) and even the currency real. However, bearish views are there as well. Experts like JP Morgan believe that no matter what happens to Rousseff, this impeachment process will delay government work and ‘paralyze the government’s fiscal agenda during the next month’ as the spotlight will be entirely on the political movement now, which might translate into a deeper recession. Whatever the case, the markets cheered the expected end of the prolonged political deadlock and pushed up these Brazilian stocks and ETFs, though we are unsure about the sustainability of these gains. Stocks to Watch Itaú Unibanco Holding S.A. (NYSE: ITUB ) The company functions through commercial bank, retail, consumer credit retail and wholesale bank segments in Brazil and overseas. As financial stocks moved up, this Zacks Rank #3 (Hold) banking giant advanced over 6% in the last two days (as of December 3, 2015). The stock has a Momentum score of ‘A’. Petróleo Brasileiro S.A. – Petrobras (NYSE: PBR.A ) The largest publicly-traded Latin American oil company has long been fraught with corruption scandal. Its high-profile officials were allegedly involved in multi-billion dollar laundering and bribery. Also, the Brazilian government, the company’s majority shareholder, has a history of political interference in Petrobras’ affairs. Thus a probe into Rousseff’s government sprung sweet surprises for this company. PBR has a Zacks Rank #3 and added 8.6% in the last two days. PBR has a Zacks Value score of ‘A’. Centrais Elétricas Brasileiras S.A. – Eletrobras (NYSE: EBR ) The company funcations in the power utility sector and together with its subsidiaries, generates, and distributes electricity in Brazil. In the last two days, the stock advanced about 12.6%. ETFs to Watch The ultra-popular large-cap MSCI Brazil Index Fund (NYSEARCA: EWZ ) added about 5.9% in the last two days (as of December 3, 2015) on blows against Rousseff and also advanced about 0.1% after hours. However, the fund is down 34.6% so far this year. EWZ has a Zacks ETF Rank #4 (Sell) with a High risk outlook. However, due to slumping activities in Brazil, it is wiser to stay away from small-cap ETFs like Market Vectors Brazil Small-Cap ETF (NYSEARCA: BRF ) and iShares MSCI Brazil Small Cap Index (NYSEARCA: EWZS ) as small-cap stocks are tied more to domestic economic activities. Still BRF and EWZS were up over 3.6% and 5.9% respectively in the last two days on calls for Rousseff’s impeachment. Both BRF and EWZS carry a Zacks Rank #5 (Strong Sell) and are down respectively 43.3% and 45.5% so far this year. Original Post

Surprise ETF Winners Post Job Data

The U.S. labor market latched on to strong job gains in November, sealing the chances of a Fed lift-off as early as in two weeks. The ‘headline’ jobs number came in at 211,000 for November, breezing past the estimated 200,000. In fact, the data for September and an already-sturdy October were also upgraded to reflect 35,000 additional jobs than earlier revealed. Notably, wages and the unemployment rate were also steady in November. The unemployment rate remained unchanged at 5% – a more than seven-year low level. The monthly tally for the last three months now averages at 218K. However, the labor market has room for further improvement. This is because the underemployment rate, which reflects part-time workers who’d wish a full-time placement and people who want to work but have stopped searching, inched up to 9.9% in the month from 9.8% in October, per Bloomberg . The labor forces’ participation rate remains at a multi-year low of 62.5% (minutely up from October). Average hourly earnings are rising off late but are far from creating wage inflation. The nudge in the underemployment metric, widely viewed as the Fed chief Yellen’s preferred benchmark for measuring the labor-market condition, hints at a slower rate hike trajectory once the Fed embarks on this path. After all, the economy is yet to attain the Fed’s 2% inflation goal. The economy has failed to reach that target after April 2012. Fed officials now expect a 74% probability of a hike, while the effective funds rate post hike is likely to be 0.375%, per Bloomberg. Market Impact While the broader market has already settled in with the looming liftoff this month, it has now started analyzing the pace of the rate hike. As a result, a good-but-not-outstanding job report, laden with a few loopholes, has strengthened the chance of a slow and small rate hike trail ahead. This produced a handful of surprise winners and losers post November job data. The belief is that when rates rise or a chance of a rise is higher, the greenback strength puts pressure on commodities and the bond market underperforms. But after the November job report, we noticed certain changes in sentiments in the investment dynamics as the market is now focusing more on a sluggish rate hike, not just the hike itself. Given this, we have highlighted ETF winners and losers from the November payroll report. Winners SPDR Gold Shares (NYSEARCA: GLD ) Gold bullions plunged to a six-year low level on a rising greenback and muted inflation globally. However, the bullion tested many lows already and the lift-off seems almost priced in, the bullion reversed its trend post job data. The bulls are back in the gold market as many analysts believe that the Fed will not react fast after initiating the policy normalization process. This gave the gold bullion ETF GLD a gain of over 2.2% on December 4, the day a steady job report published, defying the traditional investing theme. The fund added about 0.1% after hours. GLD is down over 8.4% so far this year (as of December 4, 2015). GLD has a Zacks ETF Rank #3 (Hold). iShares 20+ Year Treasury Bond (NYSEARCA: TLT ) This is a beneficiary of the positive economic momentum. Yield on the benchmark 10-year Treasury note dipped 5 basis points from the previous day to 2.28% on December 4 whereas yield on the 20-year note declined 7 bps to 2.65% on the same date. As a result, treasury bonds rose after the payroll data. Long-term U.S. bond ETF TLT was up about 0.9% in the key trading session. The fund has a Zacks ETF Rank #2 (Buy). iShares Select Dividend (NYSEARCA: DVY ) This high dividend ETF also flouted the traditional conviction that income investing slackens in a rising rate environment. Since yields on longer-term treasury bonds fell, investors rushed toward high income instruments. DVY yields about 3.29% (as of December 4, 2015) and gained about 1.6% on December 4, 2015. PowerShares DB US Dollar Bullish ETF (NYSEARCA: UUP ) A healing job market and economic improvement are attracting more capital into the country and appreciating the U.S. dollar. UUP is the direct beneficiary of the rising dollar as it offers exposure against a basket of six world currencies – euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. Though further strength in the greenback now looks limited after months of steep ascent, UUP advanced over 0.7% on December 4. iShares MSCI Emerging Markets (NYSEARCA: EEM ) Emerging markets normally fall out of favor in a rising rate environment as investors dump these high-yielding, but risky, investing tools for higher yields at home. However, the emerging market ETF EEM was up about 0.7% on December 4 and lost about 0.1% after hours. EEM has a Zacks ETF Rank #3. Loser SPDR Barclays 1-3 Month T-Bill ETF (NYSEARCA: BIL ) This product offers exposure to the short end of the yield curve by tacking the Barclays 1-3 Month U.S. Treasury Bill Index. Since the Fed hikes the short-term interest rate, yield on the benchmark 6-month Treasury note rose 4 basis points to 0.49% on December 4 and will likely to remain stressed in the coming days. Original Post

ETFs Don’t Kill Investors, Investors Kill Investors

There was a good piece in the WSJ today discussing potential “flaws” in Exchange Traded Funds (ETFs). ETFs are a relatively new product that have amassed huge quantities of assets in the last few decades, but are still dwarfed by the mutual fund space (roughly 2.1 trillion in assets, versus 12.6 trillion in mutual funds). The SEC recently said “It may be time to re-examine the entire ETF ecosystem.” That sounds a bit hyperbolic to me. ETFs aren’t necessarily dangerous unless you misunderstand them or misuse them. Unfortunately, a lot of behavioral bias appears to be driving the misguided fears about ETFs. 1. ETFs can be dangerous when misused. The first exchange-traded fund founded in 1993 was the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) which was designed to track the S&P 500. It’s a remarkably tax- and fee-efficient product that has served its investors very well since its founding. This was a very simple product designed for passive indexing, but the ETF space has morphed substantially since 1993. Much like the mutual fund space, it has morphed from a simple indexing product into a series of products that feed investor impatience and desire for rapid profits. And so we’ve seen a substantial surge in “active” ETFs, leveraged ETFs, “hedged” ETFs and other similar products. Many of these products abuse the efficiencies of ETFs by being tax-inefficient and fee-inefficient. They sell the diversification of indexing, but saddle investors with all the negatives that result in higher fees, tax inefficiencies and poor performance. I’ve written substantially on the dangers of leveraged ETFs and how fund companies sell high-fee closet indexing ETFs in exchange for empty promises about hedging and “market beating” returns. These products, in my opinion, are often dangerous and sold on false premises. But that does not mean we should make sweeping generalizations about the entire ETF space. The fact that some ETFs are bad does not mean they are all bad. ETFs are dangerous when misunderstood and misused. As Warren Buffett says, never invest in something you don’t understand. 2. ETFs traded precisely as they should have during the August Flash Crash. One of the primary drivers of the fears around ETFs was the morning of the Flash Crash in August, when many ETFs declined by 30-40% for no reason. We should be really clear about what happened earlier this year during the Flash Crash. ETFs traded precisely how they should have during this event. ETFs are liquid trading instruments designed to reflect the aggregate performance of their underlying holdings. On the morning of the Flash Crash, there were a huge number of stocks that were halted or illiquid. An ETF trades with a market price (the price you see) and an intra-day indicative value (the price the market maker sees). The market maker will try to keep the IIV as close to the market price as they can by making a market in the ETF. But when most of the underlying holdings are halted, there is no reliable IIV, and so, the price of the ETF is basically unknown until the underlying holdings open again. This problem was exacerbated during the Flash Crash because there are fewer human traders there to identify the sorts of issues that I identified in real time: Unfortunately, a lot of people didn’t understand this or implemented stop loss orders that resulted in sales well below where the ETF should have actually been trading. I watched this happen in real time, and was even able to execute buy orders at a 25%+ discount, due entirely to these behaviorally biased investors. Make no mistake, this was not a flaw in the way ETFs work. It was purely user error. ETFs are not inherently dangerous, but like many investment products, they can be abused by people who don’t understand them or misuse them. This isn’t a product flaw. It is a human flaw as old as the financial markets themselves. If you want to better understand ETFs I recommend reading the following primer from ICI or this one from BlackRock . Well informed is well armed.