Are we looking at a correction in the making in Brazilian and Chinese stock markets?

05/02/2011 3:23 pm EST


Jim Jubak

Founder and Editor,

The stock markets in China and Brazil are getting interesting.

The Shanghai Composite index was up 0.9% today but that merely takes a drop of pain out of a very bad week last week. For the week the index was down 3.3%. Shanghai stocks, while still up 3.7% for the year, were down 4.8% from their five month high on April 18.

Brazil’s Bovespa is down 0.68% as of 2:15 today. Before today’s action it was down down 5.2% this year and 7.4% from its 2011 high in January.

Now frankly I prefer “boring” to “interesting” every time. Give me a boring market that goes up in a steady rally. “Interesting” means I’ve got to figure out when I think a market is close to a temporary bottom and cheap enough so that if I’m wrong, the damage won’t be too extensive.

I think both of these markets have further to fall on the current trend. Investors in both countries are afraid that inflation is on the verge of running out of control and that central banks are going to have to really crack the whip on interest rates in order to slow growth. On my 2X rule of thumb—Remember? In a developed market a 10% drop is a correction but in an emerging market a 20% drop is a correction—I’d let these trends run for a while. (Or nibble if you must.)

But Brazil’s Bovespa has clearly moved into the cheap enough so that the damage won’t be too painful if you buy too early category. Brazilian stocks now trade at 10.7 times analyst earnings forecasts—that’s the P/E ratio on projected earnings—according to calculations by Bloomberg. That compares to 13.8 times for the Shanghai Composite and 15.5 times for Mumbai’s Sensex.

By comparison, the Standard & Poor’s 500 trades at 13.6 times projected earnings, according to Birinyi Associates. The Dow Industrials trade at 12.7 times and the NASDAQ Composite at 15.8.

The trouble with comparisons like this is that analysts can be wrong in their earnings projections. I think that’s likely to be the case for Brazil right now where estimates for the next 12 months are colored by the 7.5% economic growth of 2010. Give analysts a few months of 4.5% growth (the current estimate for 2011) and rumors (Have you heard that Brazil is going to lose the soccer World Cup?), and those estimates are likely to come down. Another reason to wait a few more months to buy or to buy only slowly right now.

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