Even after a brutal selloff last week, the worst is yet to come for Brazil’s stock market, according to some investors.
Efforts to reform Brazil’s pension system, moves aimed at cutting public debt and boosting economic growth could be derailed as troubles for Brazilian President Michel Temer, who was caught on tape discussing a hush-money arrangement to buy the silence of imprisoned former house speaker Eduardo Cunha, are likely just beginning, fund managers said.
Notching its biggest one-day drop since the depths of the financial crisis in October 2008, after news of the tape surfaced, Brazil’s benchmark Bovespa stock index tumbled nearly 9 percent on May 18.
On the belief that they have further to fall, short sellers descended on funds containing Brazilian shares.
According to S3 Partners, a financial analytics firm, about 12 percent of shares of the $5.6 billion U.S.-listed iShares MSCI Brazil Capped ETF are being shorted. By dollar value of short interest, the fund ranks as the second most-shorted country ETF in the United States.
To reimburse the lenders by pocketing the difference, investors who take short positions sell borrowed stock they hope to buy back later at lower prices.
According to Thomson Reuters’ Lipper research unit, the Brazil ETF pulled in $526 million of new money in the week ended on Wednesday, but those figures include shares created so they could be sold short.
“As EWZ’s stock price dropped, short sellers needed to short more stock in order to keep their risk positions at the same levels,” said S3 Partners managing director of research Ihor Dusaniwsky.
With most of that made the day of the big selloff, EWZ’s short sellers have a 9 percent profit since last Thursday, he said.
Investors betting that the recent selloff does not reflect fundamentals underpinning the market, could also be the source of some of the fund’s inflows.
Demand for EWZ over the past week from both short-sellers and bargain-hunting “value” investors were seen by Mohit Bajaj, director of ETF trading solutions at WallachBeth Capital LLC.
All Brazilian assets in his company’s $136 million Newton Global Emerging Markets Fund, said Robert Marshall Lee, investment leader and portfolio manager at BNY Mellon subsidiary Newton Investment Management.
With much of Brazil’s population opposed to fiscal restructuring measures like pension reform it would be difficult to pass them, Lee said, even if Temer stays in power his position has been significantly weakened.
“What you end up doing is a very watered-down version,” he said. “So the market has optimism and then gets disappointed and I think that’s the likely path ahead.”
Capital Economics senior emerging markets economist William Jackson said that Brazil and broader emerging markets are likely to end the year with lower equity prices and weaker currencies.
Yet there has been little sign of leakage into the broader emerging markets sphere of Brazil’s problems, so far. Pulling by just 0.4 percent over the most recent week and pulled in $1.1 billion in new cash was the average U.S.-based emerging market fund tracked by Lipper.
With pension expenditures accounting for nearly half of its spending before debt payments, economists warn that Brazil’s social security system is one of the main threats to government finances there. Another hurdle in Congress on Tuesday was cleared by Temer’s plans to streamline Brazil’s pension system.
(Adapted from Reuters)