Editor's note: This piece originally ran earlier today on our newest Premium service, ETF Profits . Click here for a 14-day trial to this exciting product! Brazil ETFs experienced lift-off last week. A rally in emerging-market shares benefited many ETFs, but iShares MSCI Brazil ( EWZ) gained more than 5%. The rally was particularly kind to Market Vectors Brazil Small-Cap ( BRF), which popped almost 9%. This sudden jump in the shares suggests that investors have come back to this once-favorite emerging market. Although shares have performed well over the past couple of years, 2010 was a year for leadership by the smaller Southeast Asian markets of Indonesia, Thailand, Malaysia and Taiwan. Among the BRIC nations, Russia and India were the stronger performers, while China and Brazil lagged. Brazil's underperformance left shares relatively cheap compared with the emerging-market index. Midway through 2010, Brazilian shares traded at a premium to the broader index, but now trade at a discount of several percentage points -- and as much as 10% at one point. Not spectacularly cheap, but enough that some institutional investors are increasing their allocations to the country. One source of strength for Brazil is its commitment to economic growth. The country's current president, Dilma Rousseff, was a Marxist guerrilla in the 1960s and now leads the Worker's Party. Her current slate of economic policies include payroll, investment and small-business tax cuts. The government is also cutting spending to fight inflation, which has pushed interest rates to almost 12%. The cost of living is rising quickly, too, and Rousseff angered unions by raising the minimum wage less than the demanded amount.
On the other hand, the government recently increased taxes on imported goods to help domestic industries. The reason for that policy is the strong Brazilian real. Developed economies from the U.S. and Japan to Europe currently offer negative real interest rates, so money is flowing into Brazil to obtain attractive returns. This flow of capital is pushing up the real and, last week, WisdomTree Dreyfus Brazilian Real ( BZF) gained 2.6% after it became apparent that the government may allow further appreciation. That bounce gave the Brazilian equity ETFs the extra boost they needed to turn in an impressive five-day rally. Imports became very cheap in real while exports became expensive. Many goods are cheaper overseas, which is hurting domestic industries. Overall, Brazil is suffering from growth pains, and the current round of inflation should continue to inflate the stock market, especially for foreign investors who are calculating their returns in foreign currency. BZF is at an all-time high and BRF is 10% away from a new 52-week high, though BRF does look overbought and a healthy pullback is likely. EWZ is more than 25% below its May 2008 high. At that time, oil was heading for $150 a barrel, and EWZ has large allocations in oil and mining shares. Since the inception of BRF, it has consistently outperformed EWZ. It likely will continue to outperform unless oil and mining shares begin to lead the market. If oil prices rise so high that investors fear an economic slowdown, EWZ would probably outperform BRF considerably, but that situation does not appear imminent. Investors who think Brazil is ready to improve its relative performance among the BRIC nations can go with BRF for now, but watch for a pullback this week.