In recent years, Brazil has risen to the top of the emerging markets pack, boasting almost full employment, abundant natural resources, and a booming economy. All of this has helped make the Latin American powerhouse particularly attractive to foreign investors: In the first 11 months of 2010, overseas investors poured a whopping $62 billion into Brazilian debt and stocks.

But there's a flip side to all this outsized international demand. Currency gains in the Brazilian real hit a 28-month high last week as the country's astronomical lending rate flooded the market with foreign investors. At 10.75%, their benchmark holds the promise of far greater returns than the U.S. or Japan's measly rates.

Given Brazil's reliance on their export business, the current strength of their currency is problematic -- Brazilian exporters would vastly prefer to sell their goods in cheap reals in exchange for pricey foreign money.

In response, Brazil has announced that they'll be making some drastic spending cuts, hoping to curb inflation and allow the central bank to cut down interest rates.

This move is the latest in a series of measures designed to cool the real rally. Back in October, former President Lula tripled a tax on foreign investors' fixed income asset purchases. And just last week, Brazil put a reserve requirement in place on short dollar positions in an effort to dissuade international investment.

Paulo Leme of Goldman Sachs is somewhat optimistic about the government's fiscal plans. In his opinion, if Brazil can contain credit growth and spending, the country may be able to "find a more neutral interest rate" that's "less attractive" to foreign investors.

But noted NYU economist Nouriel Roubini isn't convinced. He argues that these measures will only incentivize overseas investments: "If you do further fiscal consolidation, your country's sovereign risk premium will fall." Consequently, "inflows may become even larger."

Tough to say whether or not the Brazilian government's fiscal measures will succeed in their intended effect. But if they do, many of the country's stocks may suffer.

So which Brazilian stocks are expected to take a hit? That's a tough question, but for clues, we can look at what short-sellers are doing. Short-sellers essentially bet on their stocks to lose, selling high in order to buy low. They borrow shares from other investors, sell them on the open market, and eventually close the short by buying back the same number of shares initially borrowed. So, if the short-seller can buy back the stock at a lower price, he nets a profit off the difference.

Short-sellers take on unlimited risk because they (theoretically) have unlimited downside -- if the stock keeps rising, they keep losing, so they tend to be a bit more sophisticated than your average investor. That's why it's worth keeping an eye on their trades.

Here's a list of four Brazilian stocks being targeted by short-sellers. Is the market being too pessimistic on these names? (Click here to access free, interactive tools to analyze these ideas.)



Short Trends Between 9/30-12/31

Companhia de Bebidas Das Americas (NYSE: ABV)


Shares shorted increased from 3.17M to 8.52M (+168.77% change)

Gerdau (NYSE: GGB)

Steel & Iron

Shares shorted increased from 13.55M to 17.29M (+27.6% change)

Gafisa (NYSE: GFA)

Residential Construction

Shares shorted increased from 6.34M to 7.62M (+20.19% change)

Petroleo Brasileiro (NYSE: PBR)

Oil & Gas Drilling & Exploration

Shares shorted increased from 16.67M to 18.69M (+12.12% change)

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research. Note: The numbers on top of items represent the forward P/E ratio, if available.

Kapitall's Eben Esterhuizen and Alicia Sellitti do not own shares of any companies mentioned.

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