Brazil: A Leveraged Look

09/16/2014 9:00 am EST

Focus: ETFs

Nicholas Vardy

Editor, Oxford Wealth Accelerator

Our latest recommendation is a triple-leveraged bet on the daily performance of the MSCI Brazil 25/50 Index, explains Nicholas Vardy, editor of Triple Digit Trader.

The Direxion Daily Brazil Bull 3X Shares (BRZU) covers approximately 85% of the free float-adjusted market capitalization in Brazil.

Here's why I expect the Brazilian market to continue the monster rally that it launched at the start of August.

First, after trailing the US stock market by 38% in 2013, the difference between the relative valuations of the US market and emerging markets remains huge.

Yes, emerging markets have rallied in 2014, as the performance of the MSCI Emerging Markets Index has now overtaken the S&P 500 (SPX) this year.

Yet, despite the rally, the MSCI Emerging Markets Index is trading at a price-to-earnings (P/E) ratio of 12. That compares with a P/E of 17 times for US stocks.

That's still the largest gap since 2006.

Second, Brazil is rallying particularly strongly and has been the third-best-performing stock market in the world over the past month among the 46 that I monitor on a daily basis.

That’s mostly because polls show that incumbent President Dilma Rousseff may be replaced by a more business-friendly candidate in the next presidential election, slated for October.

And new political leadership could signal a turnaround in the economy.

Brazil’s economy is in a funk, to be sure. Gross domestic product (GDP) growth is flat. The country’s current account deficit has widened sharply and its budget deficit has soared.

Brazil even suffered a credit downgrade from Standard & Poor’s.

But it is always darkest before the dawn. And there are signs that the Brazilian economy is turning around. July industrial production rose above consensus estimates to 0.7% month over month, beating estimates of 0.5%. That may signal the start of a turnaround.

After its recent rally, the Brazilian market is no longer screamingly cheap. Brazil is now trading at a P/E of 16—though that is still below the S&P 500’s current level.

Technically, the Brazilian market has rallied strongly in the past three weeks and is technically overbought. So, truth be told, this is not the ideal time to enter this position. Any pullbacks would be the best time to add this position.

That said, the market is in a confirmed uptrend. And I expect that the combination of a favorable outcome in the election and a Q4 rally could make this bet a big winner.

Emerging markets are back on investors' screens. The asset class has outperformed the S&P 500 by 2-to-1 over the last six months. Finally, October marks the start of Q4, which traditionally is the strongest time for emerging market stocks.

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