Brazil ($EWZ) has been on my watch list for over a month now,¹ so I wanted to update what I’m seeing there while I wait.
Yesterday, I noted a technical glitch that’s getting in the way of this trade. (I’m lucky I did my analysis and saw harbingers in the FX and ETF charts, otherwise I’d be sitting with losses already.) What’s happening is a rapid devaluation of the Brazilian Real ($BRL) against $USD, which is causing a divergence between the local $BOVESPA index and the USD-denominated $EWZ ETF. To quantify that, BOVESPA is +6.85% mtd vs EWZ -0.83%.
The Brazilian government is responding to its people’s protests by allowing the currency to devalue. While there’s some argument within their government as to whether or not a weaker BRL will prove beneficial–with inflation potentially outweighing the gains in trade competitiveness–most officials seem delighted that developed markets’ experiments with unconventional monetary policy (read: Fed/QE) are drawing to a close. They’ll no longer have the import the inflation cast off from an artificially weak USD, the strengthening of which has been referred to as “a medium- and long-term trend” by a number of Brazilians.
The social unrest was exactly the kind of “purge” I had awaited to start buying, and their stock market’s selloff in June was enough of a capitulation to satisfy me, given the long term holding period I plan for this position.
I’ve waited with my finger on the trigger because EWZ’s primary pattern is a bear flag that’s sitting on trendline support right now. Despite long term 3x bull divergence, I’m waiting to see whether or not EWZ will breakdown below this classical, bearish setup. You can see the subtle differences in the chart of BOVESPA, which naturally immunizes the currency effects. BOVESPA faces a dual horizontal and trendline resistance just >52,000, so maybe an equity-risk-related pullback is in store anyway–a close presidential race engendering “uncertainty” could be the culprit:
Luckily for the longer term, the overarching construction in EWZ is a multiyear falling wedge, which will provide robust trendline support <$40. That sub-$40 target represents my new entry point, because it also represents a 50% Fibonacci retracement of a classic breakdown from the previous, long term symmetrical wedge that had governed this market. That’s all clearly illustrated by the EWZ weekly chart, wherein 2x bull divergence gives hope to the longer term bull case:
¹The quantitative and fundamental arguments for Brazil were covered here