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May 18, 2017

S3 Research: Over $700 million of Shorting in the Brazilian ETF and ADR’s Today

The Brazilian Ibovespa Index was up 12.14% year-to-date as of yesterday, May 17th, but with reports exposing another scandal in Brazil’s executive office the index is down over 9% today. Following last year’s impeachment of President Dilma Rousseff, President Michel Temer is alleged to be involved in illegal payments and a cover up scheme involving a jailed former Brazilian congressman.

Brazilian short interest had been declining as a result of their rallying market and as of May 17th, year-to-date short interest in the top ten shorted Brazilian ADR’s and ETF had decreased $769 million, or 23%. Short interest in the $5.7 billion market cap iShares MSCI Brazil ETF (EWZ US) decreased by $256 million, while inflows increased by $788 million. Both longs and shorts were getting more bullish on Brazil.

Today we saw an abrupt change of sentiment in the Brazilian market with $716 million of new short activity executed in these ten securities. Adding $303 million of mark to market price declines to today’s new short activity, short interest in these ten securities increased by $421 million to $2.993 billion, a 16% increase in just one day.

Interestingly, virtually all of the new short selling occurred in just three securities, the Brazil ETF, Vale and Petrobras. We would expect additional short selling to spill over into the rest of the ADR’s on our list if the Brazilian market continues its decline, but short activity in Itau Unibanco, Banco Bradesco and Ambev should lag as these three companies make up almost 30% of the EWZ ETF and there is less need to short these three stocks if you are already shorting the EWZ ETF.

Additionally, some of the almost $800 million of ETF inflows this year will sell off their positions and force long selling in the underling Brazilian local shares when the ETF’s are redeemed . With almost three quarters of a billion dollars shorted in just 10 securities on the initial day of Brazil’s new Presidential scandal, it would be safe to assume there will be more short activity as more information is disclosed and President Temer’s opposition party continues to stir the pot. With the threat of restrictions in the Brazilian Real currency market, short exposure via the Brazil ETF and ADR’s may be the safest way to play the downside of the Ibovespa. With over $200 million of mark to market P/L made today in EWZ, VALE and PBR there will certainly be more traders joining the shorting samba line.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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