Momentum is building in Brazil

Key points:

• The Brazil Ibovespa index surged more than 7% over the past two sessions
• At the same time, the index closed at a 30-day high but not a 126-day high
• After similar momentum breakouts, the Ibovespa was higher a month later 77% of the time

Should we buy the momentum breakout in Brazil?

Brazil is a market I'm keeping an eye on for trade ideas as the central bank stayed put at its most recent policy meeting in September. While they could undoubtedly press the hike button again, a further pause or even pivot to an easing cycle would be a welcome development.

On Monday, the Brazilian Ibovespa index surged over 7% in two sessions and closed at a 30-day high but not a 126-day. The momentum breakout triggered a buy signal for Brazilian stocks.

Momentum breakout signals preceded positive returns for the Ibovespa index

The Ibovespa index performed well after momentum breakouts, especially a month later. The signal shows a positive return in all but two instances at some point in the first month. 

The 126-day high condition is a critical part of the breakout model as it ensures that the system buys with the index below a medium-term resistance level. For that reason, the 3 & 6-month time frames show excellent results. U.S. dollar-based traders can use the iShares ETF (EWZ) as a proxy for the Ibovespa index.

It's all about central bank policy

The Brazilian central bank has been on an aggressive tightening cycle, hiking the target rate 12 times since March 2021. However, at the September meeting, the central bank paused. Since the meeting, the Ibovespa index is up 3.84% versus a flat return for the S&P 500.

Suppose I isolate the momentum breakout signals based on when the Brazil central bank was either tightening or had paused after a tightening cycle. In that case, the model performed well across all time frames, especially three months later. 

What the research tells us...

The Brazilian Ibovespa index surged to a 30-day high but not a 126-day high, triggering a momentum breakout signal. After similar momentum breakout alerts, the Ibovespa index showed favorable returns, win rates, and z-scores across several time frames. The results were excellent if a signal occurred in a tightening cycle or after a hiking cycle pause. The pivot matters.