Oct. 27 (Bloomberg) -- Brazilian stocks fell the most in four months, led by homebuilders, on concern about valuations and the prospect a foreign investment tax will hurt inflows.

Rossi Residential SA and Gafisa SA dropped the most on the Bovespa after the homebuilders’ price earnings reached the highest levels in more than a year. Cyrela Brazil Realty SA Empreendimentos e Participacoes slumped 6.9 percent before it prices its 43 million offering of new voting shares. Vale SA, the biggest iron ore miner, fell 4.5 percent on concern governments around the world are winding down stimulus efforts.

“The market isn’t so cheap anymore like it was before,” said Fabio Cardoso, a partner at Adinvest Consultoria, a Rio de Janeiro-based consultancy and fund management firm. “It still needs some confirmation.”

The Bovespa fell 3 percent to 63,161.04. The BM&FBovespa Small Cap index slid 2.6 percent. The real fell 0.7 percent to 1.7448 against the dollar. Mexico’s Bolsa lost 3.2 percent and Chile’s Ipsa fell 1 percent.

The Bovespa has surged 68 percent this year, sending its price to 22.10 times reported earnings, near a five- year high and above the 21.03 price-to-earnings ratio of the MSCI Emerging Markets index.

“Brazilian equities keep performing vigorously, challenging analysts’ expectations and reaching new valuation highs,” wrote Itau Unibanco Holding SA strategist Carlos Constantini in a note to clients today. “Multiples appear stretched, continuously expanding, as recent share price performances have not been accompanied by the corresponding increases in analysts’ forecasts.”

Homebuilders Decline

Gafisa dropped 7.1 percent to 27.72 reais. The shares last week traded at almost 40 times trailing earnings, the highest level since 2007, according to Bloomberg data.

“One thing is certain and that’s that the stock isn’t cheap,” said Silvio Araujo, a real estate analyst at Lopes Filho & Associados in Rio de Janeiro.

The shares have dropped 7.5 percent in the past week since the government imposed a 2 percent tax, known as IOF, on the purchase of equity and fixed-income assets by foreigners.

“The market as a whole is still feeling the effects of the IOF, and foreign investment in this industry is extremely relevant,” Araujo said in a phone interview. Foreign investors bought 72 percent of shares sold by Gafisa in its 2006 IPO. They snapped up 93 percent of shares sold in a secondary offering in 2007, according to exchange owner BM&FBovespa SA’s Web site.

Stock Sales

Speculation that Gafisa will sell stock in the first half of 2010 to bolster its finances after selling 600 million reais in debt is also pulling down shares, Araujo said. Gafisa cancelled plans to sell shares earlier this year.

Gafisa’s spokeswoman at an outside press office in Sao Paulo wasn’t available to comment.

Cyrela fell 1.67 reais to 22.40 reais. The public offering may include an over-allotment of 15.05 million shares, the Sao Paulo-based company said in a prospectus posted today on the Web site of the securities regulator. Without the over-allotment, the offer will be worth 983 million reais ($565.3 million) based on the current share price.

Rossi Residential lost 94 centavos to 12.05 reais. The company’s valuation is at the highest since June 2008.

Shareholders of Cetip SA - Balcao Organizado de Ativos & Derivativos, Brazil’s biggest clearing house, are raising up to 881.4 million reais ($509 million) in the nation’s fourth initial share sale this year. The share sale is Brazil’s 10th in the past five weeks as companies seek to tap into the rally.

Emerging-market stocks fell the most in two months on speculation the move by India may signal Governor Duvvuri Subbarao will raise borrowing costs by year-end. Norway will probably become tomorrow the first European country to raise interest rates since the credit crisis began, according to a Bloomberg survey of economists.

Vale Drops

Vale lost 4.5 percent to 39.65 reais. The miner is a major exporter to emerging markets such as China, where commodities demand has been bolstered by stimulus spending.

Gerdau SA, Latin America’s largest steelmaker, dropped 3.9 percent to 27.50 reais. U.S. Steel Corp., the largest U.S.-based steelmaker, reported its third consecutive quarterly loss as revenue declined amid a drop in global demand.

Dollar Risk

The biggest risk facing Latin American stock markets is a rebound in the dollar, Citigroup Inc. strategists said.

There has been a “tight correlation” between a falling dollar and rising Latin American equities since 2002, Citigroup strategists Geoffrey Dennis and Jason Press wrote in a note.

“The biggest fundamental risk of a decent correction in regional equities is, therefore, a bounce in the dollar,” they wrote. “The most likely trigger for this is anticipation of the first U.S. rate rise, which our economists expect to occur around mid-2010. In short, as markets enter 2010, the timing of the first Fed move will come closer and the dollar could bounce, triggering a more severe correction in regional equities.”

The real’s 33 percent, world-beating rally this year pushed up the price of a Big Mac in Sao Paulo above that in New York and London, a measure often used by the Economist magazine that would indicate the currency is overvalued.

The real will keep strengthening unless the country implements “radical measures” to arrest its rally, said Paulo Fujisaki, a foreign exchange analyst at Socopa Corretora in Sao Paulo.

Mexico Stocks

The Bolsa declined for a fifth day on homebuilders’ “disappointing” third-quarter results, said Marcos Duran y Casahonda, an analyst with Scotia Capital in Mexico City.

“Demand has fallen off this year. Buying a house is a big decision, and people are a lot more cautious,” Duran y Casahonda said in a telephone interview.

Corporacion Geo SAB led declines on the index, losing 7.2 percent to 34.89 pesos. Mexico’s second-largest homebuilder fell after reporting third-quarter earnings that trailed estimates. Urbi Desarrollos Urbanos SAB retreated 5.8 percent to 27.09 pesos after reporting third- quarter profit that was 20 percent lower than the average of three estimates compiled by Bloomberg.

America Movil SAB, Latin America’s largest mobile-phone company, lost 4.2 percent to 29.41 pesos after losing prepaid subscribers in Mexico for the first time.

To contact the reporters on this story: Paulo Winterstein in Sao Paulo at pwinterstein@bloomberg.net; Emily Schmall in Mexico City at eschmall@bloomberg.net

Last Updated: October 27, 2009 17:37 EDT