Calling all regime changers: here is how to make money from the ongoing political crisis in Brazil.
With legislation gridlock likely to contain the threat of negative fiscal policy making, Thursday's selloff in Brazilian debt and equities is an attractive opportunity to go long, Bretton Woods Research said in a note to clients after market hours yesterday. "We recommend a long position in Brazil through the ProShares Ultra MSCI Brazil Capped exchange-traded fund (UBR)," says Vladimir Signorelli, founder of Bretton Woods, a boutique investment research firm out of Long Valley, NJ.
Keep in mind, that's a cowboy trade. That ETF closed Wednesday at $76.71. On Thursday it closed at $52.04. These are double leveraged funds, meaning for every dollar the fund invests, it borrows a dollar to buy more. If the iShares MSCI Brazil goes up 5%, the ProShares Ultra Brazil will go up 10% due to leverage. The same happens in the reverse.
"We believe there is about 30% upside in UBR," Signorelli wrote in a note to clients. They recommend a 15% stop/loss threshold from Thursday's close on this short-term trade.
Brazil got a kick in the head on Thursday following the revelation that President Michel Temer sought hush-money to silence a political opponent currently serving 15 years in prison for money laundering in the massive Petrobras corruption scandal. Temer is already under investigation by the Electoral Court (TSE) for being on the receiving end of illicit funds used for his 2014 re-election campaign with Dilma Rousseff. Dilma was impeached last year. If the TSE court rules that Temer, and Dilma, used undocumented money to fund their campaign, their win would be voided and he would be asked to step down. Temer said yesterday that he would not resign.
In the instance that he leaves office, a new leader would be chosen by congress, giving Brazil its third president in a year. The market would likely tank further on the news, giving short sellers a shot at capitalizing on Brazil's political pain.
See: American Investors Not Ready To Give Up On Brazil Just Yet -- Forbes
Temer: Not Resigning -- CNN
These Guys Love Petrobras -- Forbes
The political crisis does not bode well for reforms bills currently sitting in congress.
Languishing pension and labor reforms have virtually no impact on the Brazilian growth outlook, Signorelli believes. With the legislative agenda likely brought to a standstill due to this latest political development, gridlock also contains the threat of negative fiscal policy during the next 18 months. General elections are not scheduled until October 2018 and snap elections, which require a constitutional amendment, look unlikely.
Meanwhile, the Brazilian central bank is on the offensive with rate cuts. Annualized inflation of 4.2% as of the fourth quarter was well within the bank’s 4.5% inflation target. Since August 2016, the bank has reduced the benchmark rate 300 basis points, falling to 11.25% as of today from 14.25%. Futures markets see a 73% probability of a 75 basis point cut this month and so long as the Brazilian real strengthens back to where it was previously, at R$3.09 to the dollar on Monday, there is likely more room for rate reductions.
Itau Unibanco thinks rates end the year at around 7.5%. Lower interest rates is helpful for a rebound in equities..."once the panic subsides," Signorelli says.
"A one day move like that is something usually defined as 'blood in the streets.' That's the time to buy," says Timothy Seymour, a host of CNBC Fast Money and hedge fund manager at Triogem Asset Management in New York. "I would not be scared to nibble."
