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EWZ – November Review: The Political Crisis Deepens

Summary Share price of the iShares MSCI Brazil Capped ETF declined by 1.53% in November. The development was driven mainly by the political factors. The economic situation of Brazil is worsening, the political crisis is deepening and the financial markets would welcome the fall of president Rousseff. The iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) lost 1.53% of its value in November. Although it was up by more than 11% at one point, it lost all of its gains during the last days of the month, as the political crisis deepened and investors started to fear that the government will be unable to enforce the needed economic reforms and budget cuts. The economy is still in a bad shape, the latest data show that it declined by 4.5% y-o-y in Q3, which is worse than expected. The unemployment rate is at 7.9% and growing and inflation is in the double digit area. Shares of the beverages producer Ambev (NYSE: ABEV ) are still the biggest holding in EWZ’s portfolio, with weight of 10.61%. Ambev is closely followed by preferred shares of Itau Unibanco (NYSE: ITUB ) (10.24%). Besides Ambev and Itau Unibanco, only preferred shares of another bank, Banco Bradesco (NYSE: BBD ), have weight over 5%. The 10 biggest holdings represent 61.47% of the portfolio, which is slightly less, compared to 62.22% in October. Generally, no significant changes in the structure of EWZ could be observed in November. Only common shares of Vale (NYSE: VALE )are not among the TOP 15 holdings anymore, as their value declined sharply after the disastrous dam collapse . Source: own processing, using data of iShares.com Out of the 15 biggest EWZ holdings, the biggest gains were recorded by Fibria Celulose (NYSE: FBR ) in November. The credit rating of the pulp and wood producer has improved, it has completed the financial package for its Horizonte 2 project and it declared a dividend that will bring to its shareholders dividend yield over 7%. Shares of the company grew by 8.72% in November. Shares of the Brazilian airplane producer Embraer (NYSE: EBR ) jumped by 7.5%. For Embraer, November was the third consecutive month of very big gains. On the other hand, November was very negative for Vale. After the dam collapse, shares of the miner declined strongly. Preferred shares of Vale lost almost 25% of their value. (click to enlarge) Source: own processing, using data of Bloomberg The traditionally high correlation between EWZ and Petrobras (NYSE: PBR ) share price was disturbed during the first two weeks of November, although it increased back to its normal levels in the end of the month, after the corruption scandal became one of the main topics of discussion again. Also, the correlation between EWZ and oil prices (represented by the United States Oil ETF (NYSEARCA: USO )) and between EWZ and S&P 500 was relatively low or even negative during the better part of the month. One could say that the Brazilian share market lived its own live and the share price development was driven by the political situation in the country and by the efforts to enforce the austerity measures. (click to enlarge) Source: own processing, using data of Yahoo Finance November was a relatively calm month for EWZ. Although the EWZ share price was up by 11% only a couple of days before the end of the month, but eventually ended the month with a 1.5% loss, the overall volatility measured by the 10-day moving coefficient of variation was lower compared to most of the 2015. It moved in the 1%-3% range for the better part of November, however it broke out of this range in the last days of the month. Given the early December developments, December will be probably more volatile compared to November. (click to enlarge) Source: own processing, using data of Yahoo Finance Some of the more interesting news: Fibria announced that the estimated capex for the Horizonte 2 Project has been revised from $2.5 billion to $2.2 billion. The expenditures will be funded by a combination of its own cash, Agribusiness Receivables Certificates and credit facilities, the estimated average borrowing cost is only 2% p.a. The company also announced that Moody’s has improved its credit rating from Ba1/Positive to Baa3/Stable. Fibria will pay a dividend of approximately $0.96 per shares, which means a dividend yield of over 7.2%. On November 5, a disaster occurred in southern Brazil. A tailings dam owned by iron miner Samarco collapsed and more than 60 million cubic meters of toxic mud destroyed the town of Bento Rodrigues and contaminated the Rio Doce river. Samarco is a 50:50 joint venture of Vale and BHP Billiton (NYSE: BHP ) and the disaster had a significant impact on share prices of both companies. According to the latest news, Brazil sued Samarco for $5.3 billion over the spill. Cemig (NYSE: CIG ) won generation concessions for 18 hydro plants with total installed generation capacity of 699.57 MW. The new concessions should partially offset the probable loss of the Jaguara and Sao Simao concessions with total installed capacity of 2,134 MW. Companhia Siderurgica Nacional (NYSE: SID ) together with an Asian consortium consisting of ITOCHU Corporation ( OTCPK:ITOCY ), JFE Steel Corporation, POSCO (NYSE: PKX ), Kobe Steel ( OTCPK:KBSTY ), Nisshin Steel ( OTC:NSSSY ) and China Steel Corp. ( OTC:CISEY ) combined some of their assets into a new company Congonhas Mineiros. The new company will consist of an iron ore mine, railroad and port and it will be 87.52% owned by CSN and 12.48% owned by the Asian consortium. A prominent member of the ruling Workers’ Party, senator Delcidio do Amaral, was arrested due to his participation in the Petrobras related corruption. Amaral is a close collaborator of president Rousseff. His arrest further supported the voices calling for Rousseff’s impeachment. Conclusion As the early days of December showed, the Brazilian share market is still strongly affected by the Petrobras corruption scandal and the related political crisis. On December 2, the impeachment proceedings against president Rousseff opened in the lower house of Congress. As a result, the EWZ share price jumped by almost 6% in two days. The financial markets welcomed the vision of a government change and if further developments indicate that Brazil will be able to get rid of Rousseff, EWZ will grow further.

5 Lessons Learned From VIX ETFs

The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. There are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. This index functions by measuring near-term volatility expectations from options activity on the S&P 500 Index. It’s calculated on an intra-day basis, so investors are able to watch as implied volatility expands or contracts in real time. The CBOE has a nice primer on how this is accomplished that you can read here . As many ETF investors know, you can’t invest directly in an index. So the forward-thinking asset managers at Barclays, ProShares, and VelocityShares set out to create several products to help you invest in the movement of the VIX Index. According to data from ETF.com, there are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. The two largest funds in this space are the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ: XIV ). Both of these funds currently have over $1 billion in assets under management. VXX is a bet on the expansion of volatility, which typically comes during a correction or choppy stock market action. Conversely, XIV is an inverse play that rises when volatility contracts. This fund is intended to move higher as stocks move higher and greed takes a more prominent position in investor sentiment. There are also many other flavors of VIX funds that offer varying degrees of unique tracking and index construction methodology. Nevertheless, XIV and VXX work well as benchmarks to understand this unconventional asset class. I have been watching and even invested small amounts in these funds for my personal accounts at one point or another and these are the lessons I have learned from the experience. They aren’t for the faint of heart. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. It’s difficult to use these as a forecasting tool and they are often susceptible to VERY fast swings in price . They should truly only be used by disciplined traders, investment professionals, or those who understand their unconventional nature. In my opinion, they should only be held for very short periods of time with a tight stop loss to guard against significant downside risk. They don’t track all that well. These VIX funds work by tracking futures contracts similar to a commodity fund like oil or natural gas. That in itself causes problems in accurate price movement over long periods of time as complicated forces like contract rolls, contango, and expenses work against these products. The chart below depicts an overlay of the actual CBOE VIX Volatility Index and VXX. The movements are certainly correlated to a degree, but you can see how over time the price of the exchange-traded product continues to decay versus the spot price of the index. They aren’t cheap. The listed annual expense ratio of VXX is 0.89% and XIV is 1.35%. It should be expected that a fund investing in futures contracts will naturally generate higher expenses because of the complicated nature of the process. Nevertheless, it’s important to understand that these funds are going to eat into your pocketbook as well. Some come with tax headaches. Most of the investable VIX funds are structured as exchange-traded notes, which do not experience adverse tax consequences. However, if the fund is structured as an exchange-traded fund, it may be susceptible to tax consequences in the form of a K-1 that must be accounted for as well. The K-1 is generated because you are participating as a shareholder in a partnership rather than a trust. It goes without saying that you carefully read the prospectus before investing in any of these funds. They are entertaining to watch. Regardless of whether you use these vehicles, they can be entertaining to watch and also offer some insight into the market’s fickle machinations. VIX ETNs allow individual investors the ability to monitor in real time the current sentiment towards stocks and may provide a piece of the puzzle for short-term traders. They also offer a technical dynamic that may be useful for investors who are fans of relative strength or other momentum indicators. Sharp inflection points in the VIX may point towards a turning point in the market that precedes a big move (up or down). The bottom line is that these products are primarily geared for advanced users with a high tolerance for risk and sophisticated knowledge of the markets. Those that choose to dabble in these funds should only do so with a well-defined risk management plan that protects your capital in the event of a reversal.

3 Economic Headwinds That Matter More Than You Think

It is not surprising to see central bank authorities describe current economic circumstances in glowing terms. Unfortunately, the U.S. economy may not be in the greatest shape. The jobs picture is not as rosy as the Fed would have us believe. Neither is household spending. Manufacturing is a mess, while the global economy is under serious pressure. Is the U.S. economy on solid footing? Federal Reserve Chairwoman Janet Yellen seems to think so. In particular, Yellen expressed confidence in household spending as well as job growth during prepared testimony before Congress on Thursday. It is not surprising to see central bank authorities describe current economic circumstances in glowing terms. Later this month, members of the Federal Reserve Open Market Committee (FOMC) hope to hike borrowing costs for the first time in nine years. Unfortunately, the U.S. economy may not be in the greatest shape for the Fed to act. For example, while the headline unemployment rate is only 5% – a condition that Yellen describes as close to full employment – the percentage of working-aged Americans (25-54) with a job has not been this low in more than three decades. (Back then, Michael Jackson was thrilling music fans with “Thriller” and Prince was going insane with “Let’s Go Crazy.”) Let’s examine the chart above in detail. The 25-54 year old demographic is the prime working-aged sector of the American population. Grammy and grandpa are not the ones who have stopped working entirely; rather, millions upon millions of 25-54 year olds are no longer counted as participants in the workforce. Indeed, when you strip out millions upon millions of working-aged individuals, your headline unemployment rate is going to move lower. Yet that’s not full employment. How can we be close to full employment when 19.3% of 25-54 year old Americans don’t hold a job? If you want to see genuine job growth, look no further than 1985-1989 and 1995-1999. During those periods, you see the percentage of 25-54 year olds with employment catapulting higher. During a five-year span (1989-1994) that encompassed the early 1990s recession? Jobs were hard to come by. That’s why one can see the flattening of the 25-54 year old demographic at that time. Similarly, one of the reasons that the mainstream media called the 2002-2007 economic expansion a “jobless recovery” was due to the flattening of the labor force participation rate in the 5-year run. How, then, can Fed committee members express so much confidence about labor market gains? At best, the chart might be showing signs of a bottoming process, where the new normal is a 19% rate of unemployed Americans (25-54). The rate of decline does appear to have slowed over the last few years. At worst? The pace of declines in the percentage of working-aged individuals who have left the workforce re-accelerates. Of course, Yellen did not merely point to labor gains in Thursday’s testimony. She described vibrant household spending in a nod to a service-oriented economy. What are the problems here? For one thing, families are planning to spend less in the coming year. According to the New York Fed Survey of Consumer Expectations, the median household expects its spending to grow a mere 3.47% as of mid-October, which happens to be near its lowest level in the survey’s two year history. Similarly, the Conference Board’s Consumer Confidence Index fell to 90.4. Not only did the reading on consumer confidence severely miss consensus estimates of 99.5, it was the lowest reading since September 2014. It gets worse. The personal savings rate hit 5.6% in October – the highest level since December of 2012. The combination of higher savings, lower confidence and plans to curtail spending habits hardly supports Yellen’s contention that household spending will be a bright spot. Of course, sometimes what Fed committee members don’t say about the economy is telling as well. Yellen seems entirely unperturbed by the manufacturing sector’s flirtation with recession. That was not the case in 2012 when the Federal Reserve unleashed its boldest stimulus measure to date – a third iteration of quantitative easing affectionately dubbed “QE3.” Then, the prospect of a manufacturing recession mattered. Now it’s irrelevant? From my vantage point, the manufacturing slide is very relevant. First of all, the more important service-oriented sector will have to demonstrate impressive acceleration to offset the drag of a shrinking manufacturing sector. (The personal savings rate, household spending plans and consumer confidence are not particularly supportive of such an offset.) Second, manufacturer struggles forewarn additional layoffs in high-paying jobs as well as ongoing corporate revenue declines at U.S. multinationals. Demand by foreign countries continues to wane. Granted, Yellen tried to boost morale when she explained that downside risks from abroad have lessened. Unfortunately, this one does not pass the sniff test. At least one financial institution, Citi (NYSE: C ), expects China to become the first major emerging market to slash interest rates to zero, precisely because of economic deceleration. Meanwhile, Brazil’s economy shrank by a monumental 4.5% in its most recent reading. The fact that Brazil’s gross domestic product fell by a record 4.5 per cent in its third quarter tells you that Latin America’s largest country is staring down the barrel of one of its worst recessions ever. Okay, then. The jobs picture is not as rosy as the Fed would have us believe. Neither is household spending. Manufacturing is a mess, while the global economy is under serious pressure. What does it all mean for stock investors? Well, if you believe perma-bull hype, stocks are in phenomenal shape. On the other hand, if you look beyond the S&P 500 – if you examine broader market indices like the New York Stock Exchange (NYSE) Index – you have reservations about overexposure to stock risk. Consider the admonition of billionaire hedge fund manager, David Tepper, in May of 2014. “Don’t be too frickin’ long.” That was 18 months ago. For those who insist that the stock market keeps grinding higher, broader stock market indices suggest otherwise. The commentary herein, and the caution that I have been expressing since early 2014, has focused on how one should position himself/herself in late-stage bull markets. Long-time readers understand that the majority of my clients still own long-time positions such as the Vanguard High Yield Dividend ETF (NYSEARCA: VYM ), the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the iShares USA Minimum Volatility ETF (NYSEARCA: USMV ) and the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). What I have largely proposed over the last 18-21 months is that investors reduce their overall exposure to risk, lightening up on the asset class canaries – small caps, high yield bonds, commodity-related companies and emerging markets. In other words, don’t be too freakin’ long. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.