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The Scariest Trade on the TSX Could Also Be the Most Lucrative

Surprise, surprise. Brazil’s got another presidential scandal.

President Michel Lerner, in office for fewer than 10 months after replacing impeached former president Dilma Rousseff (she was removed from her position due to a corruption scandal), is in hot water.

Evidence exists that suggests Lerner okayed the payment of bribe money by Brazil meatpacking billionaire Joesley Bautista to keep former house speaker Eduardo Cunha, already in jail, from testifying in the graft probe.

Brazil’s stocks getting crushed

The latest corruption news caused Brazil stocks to drop 8.8% May 18, its worst one-day performance since 2008. Things got so crazy that the Bovespa was temporarily halted for trading after an initial 10% decline triggered the exchange’s circuit breakers.

Analysts immediately downgraded Brazilian stocks to “neutral” from “buy”, citing the increased risk that the country’s much-needed economic reforms wouldn’t be implemented as planned.

Most rational investors are running away from the fire, but for those of you risk-takers out there, this latest scandal could be the very early stages of a long run-up in Brazilian stock prices that could last years, perhaps even a decade or more.

Here’s why.

Latest scandal good for country

Corruption in Brazil is as old as the country itself. My wife’s hairdresser is from Brazil, and whenever I bring up anything to do with her birthplace, she brings out the corruption card. It’s a part of the culture.

This is why I think this latest scandal is a good thing for investors interested in betting on Latin America, as I’m wont to do.

The only way Brazil and other countries in Latin America prone to corruption are going to bring long-term stability to their economies and stock markets is by stamping it out wherever it exists.

“Markets will overreact, but the reality is that Brazil is rooting out the corruption that has plagued it for centuries,” James Gulbrandsen, a Rio de Janeiro-based portfolio manager at NCH Capital said in The Globe and Mail. “This significantly increases the likelihood of new elections within the coming months.”

I’m confident that in the next five to 10 years, Brazil society will rise to the task and create a more transparent, open economy, and when that day arrives, you can bet Brazil’s stock prices will be significantly higher.

The ETF in question

The ETF in question is the iShares MSCI Brazil Index ETF (TSX:XBZ); shares dropped 17.2% in a single day of trading on the corruption news. That’s almost double the Bovespa itself. However, as I write this, the XBZ is up nearly 5%, regaining some of those losses.

The XBZ is a TSX-listed version of the iShares MSCI Brazil Index (ETF) (NYSEARCA:EWZ), an ETF that tracks 59 mid- and large-cap Brazilian stocks whose average market cap is US$21.6 billion. These are big companies participating on a global scale. It’s up almost 7%.

Heck, Brazil is the home of 3G Capital, the guys behind Restaurant Brands International and Kraft Heinz. They don’t seem to be doing too badly.

What’s the play?

If you take a look at EWZ’s chart since its inception in July 2000, you’ll notice that it has traded around US$20 on two occasions: the first time in February 2016 and the second in November 2004, more than 11 years earlier.

Currently, it trades around US$35 — the same level as in late 2008 and early 2009 when stocks went into the toilet on a global basis.

So, I see the potential downside being about US$15, but the upside as much as US$65 based on an all-time high of $99.22, a price it hit on May 30, 2008, just before the financial crisis struck.

Bottom line

Betting on Brazil isn’t a gamble you should make if you’re saving for your children’s education or if you’re about to retire. However, if you can handle the risk, buying the XBZ, itself a proxy of EWZ, you’ll do very well in the long run.

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Fool contributor Will Ashworth has no position in any stocks mentioned.

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