Divergence Unveiled: Ibovespa & S&P500

“Emerging markets conclude 2023 on better note than developed markets” – S&P Global Market Intelligence.
How much of this has been reflected in the respective market indices?

Figure 1: Ibovespa and E-mini S&P500 Index Futures
Figure 1 presents a retrospective view of the Ibovespa Index Futures (IND1!) and E-mini S&P500 Index Futures (ES1!) since the onset of the pandemic. While the indices initially traded in tandem, a noticeable deviation emerged since the middle of 2021. The IND Futures to ES Futures ratio testing long-term resistance at 25 raises questions about a potential rebound or breakout to the downside. Let's delve into the methodologies of these two index futures to gain insights into their recent divergence.

Index Methodology and Weightings
Figure 2: Top 10 Constituents of Both Indices
Examining the top 10 constituents of both indices in Figure 2, we observe fundamental differences. Despite their similarities as float-weighted benchmarks for large-cap stocks in their respective countries, the Ibovespa Index comprises 86 stocks compared to the SP500's 500. This fundamental distinction results in a significantly larger total weight for the top 10 constituents of the Ibovespa Index, suggesting that IND future prices are more susceptible to the performance of its leading components.

Ibovespa Driven by Global Commodity Prices
Figure 3: Ibovespa vs Brent Crude Oil, Nickel, and Iron Ore
Dominated by the Energy, Financials and Basic Materials sector, the combined weight of VALE SA and PETROBRAS holds significant influence. While VALE SA is the largest producer of iron ore and nickel in the world, PETROBRAS is heavily involved in the petroleum industry. Their earnings are likely to increase following an increase in the traded prices of iron ore, nickel, and crude oil, respectively.
Positive correlations with Nickel, Iron Ore, and Crude Oil Futures prices indicate periods marked in grey boxes since the pandemic, where fluctuations in commodity futures potentially explain observed patterns in IND prices.

Figure 4: Global Commodity Index
Hence, given IND1!'s demonstrated sensitivity to commodities, understanding the general trajectory of commodities becomes paramount. The S&P Goldman Sachs Commodity Index (GSCI) provides an overview for commodities. In Figure 4, the GSCI acts as a good proxy for the commodities cycle and direction, here we observe a 30% correction from the peak, erasing some of the gains derived from the post-pandemic recovery and the Russia-Ukraine war. However, since the beginning of 2024 we see signs of a potential trend higher with the index starting to creep higher.

Figure 5: Bullish Trends Observed on Multiple Commodities
Is this just part of the usual price volatility for commodities or is the move higher significant? A detailed scrutiny of recent price movements in Figure 5 reveals a bullish outlook for all three previously examined commodities, relevant especially to the Ibovespa Index. The breakout from an ascending triangle in Brent Crude Oil Futures, the price rebound from historical support in Nickel Futures, and the testing of the upside trendline in Iron Ore Futures collectively indicate a prevailing bullish bias, perhaps suggesting more to the broader move higher for commodities.

Are Lower Rates Better?
Figure 6: Changes in Rates and USDBRL on Ibovespa
The Financial Sector, with significant weight in the index, is examined. While higher interest rates expand profit margins of financial institutions, extended periods of tight monetary policy can expose vulnerabilities and increase loan losses.
Since August 2023, Brazil’s Central Bank Monetary Policy Committee, Copom, has had five consecutive rate cutes up to a cumulative total of 250 basis points while the market continues to alter bets on the Fed’s first rate cut. Intriguingly, while interest rate parity would suggest a strengthening USDBRL, the observed weakening suggests a unique deviation.
Furthermore, as the Fed gains more confidence, evidenced by each data print, the likelihood of impending rate cuts becomes more apparent. Conversely, the outlook for further cuts by Copom is less clear due to persistently high inflation. Interpreting these factors collectively points towards a weaker USDBRL and a correspondingly stronger IND1!; as suggested by the historical inverse relationship between Ibovespa and USDBRL observed in Figure 6.

Additional Support for Ibovespa
Figure 7: Brazil’s Growing Net Exports
The rolling average of the net exports, although exhibiting some degrees of seasonality, seems to be a leading indicator of the IND prices. The reversal and positive trend in the rolling average of net exports since 2015 aligns with the climbing IND prices, indicating substantial support from Brazil's trade balance.

EM Still an Attractive Option
Figure 8: Comparing Both Index Futures’ RSI
Figure 8 brings to light yet another noteworthy point, using the ES1! as a proxy for the Developed Markets (DM) and the IND1! as a proxy for Emerging Markets (EM), we see the DM significantly overbought relatively to the EM. Hence, we argue that there is further room for the EM Index to grow.

Putting into Practice
Figure 9: Setting up the Trade
Looking at a shorter timeline, Figure 9 unfolds a compelling narrative marked by a recent decisive breakout from an inverse head and shoulders pattern. This breakout, coupled with the notable reversal in commodity prices, Brazil’s improving balance of trade, a weaker USDBRL, and the RSI not yet overbought; we lean bullish on the IND1!.
To express this view, we can long the Ibovespa Index April 2024 Futures (INDJ4) at the current price level of 129,070.
• We can set the take profit by adding the difference between the neckline and the bottom of the head (24,695), to the neckline (121,980). This puts our take profit at 146,675 and a hypothetical gain of:
146,675 – 129,070 = 17,605 points.
• Likewise, we can set the stop loss at the neckline (121,980), which brings us a hypothetical maximum loss of:
129,070 – 121,980 = 7,090 points.
• Each point is equivalent to 1 BRL.

Overall
In summary, understanding the intricate dynamics between global commodity prices, monetary policies, and trade balances provides valuable insights for anticipating the trajectory of the Ibovespa Index Futures in the evolving financial landscape.