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Brazil’s Downgrade: What It Means for Investors

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Sep. 16 2015, Published 12:52 p.m. ET

Brazil downgraded and investors seemed prepared

The Russian stock market, as gauged by the VanEck Vectors Russia ETF (RSX), fell 7.40% on January 26, 2015, when Standard & Poor’s downgraded Russia’s sovereign credit rating to the “junk” level, while the iShares MSCI Brazil Capped ETF (EWZ) only fell 0.34% at the close of trade on September 9 in reaction to the same news for Brazil. On September 9, Standard & Poor’s downgraded Brazil’s sovereign credit rating to “junk” status. Brazilian stocks like Itau Unibanco (ITUB), Vale (VALE), and Ambev (ABEV) fell at the close of trade on September 9.

[marketrealist-chart id=654755]

EWZ opened lower by 2.40% on September 10. The news of Brazil’s credit rating downgrade has definitely shaken investor confidence in the economy. However, it didn’t shake it to the extent you would have expected. EWZ fell 1.45% on September 10.

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What could lead to a massive sell-off in Brazilian equity?

A rating downgrade, that demotes a country’s sovereign debt to “junk” or “non-investment grade” status, is always followed by a sell-off in the market for that economy’s stocks. While retail and active institutional investors are prompt to react to news and quickly attempt to dilute their holdings, passive investors usually take time. This leads to a fall in equity prices.

Currently, S&P holds Brazil at the junk level, while Fitch and Moody’s (MCO) still consider the economy’s sovereign debt as “investment grade.” However, Fitch has a negative outlook on the economy, while Moody’s rating for Brazil stands on the brink of falling into the “non-investment grade” category. Another junk rating for Brazil and the markets will likely react more adversely. Stocks may see a fall with passive investors also looking to dilute their holdings. This would lead to a massive sell-off.

The reaction to the rating downgrade on September 9–10 wasn’t that pronounced. Next, we’ll investigate why.

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