Latin American markets have enjoyed mixed fortunes. The smaller markets have struggled, but investor confidence in the big two – Mexico and Brazil – has been high
Latin America has not been immune to the depredations suffered by emerging markets this year, but the region’s
overall performance has been promising.
Perhaps the biggest surprise was how resilient the equity markets proved in the wake of the 40% devaluation of the Brazilian Real in January. The Brazilian IFCI index even finished the first quarter 5.5% higher in dollar terms.
Part of the reason for increased investor confidence was the evidence of political will to tackle the problem, in contrast, some would say, to what happened in Russia.
Nevertheless, fund managers found it
difficult to match the regional benchmark indices during the first half of the year.
Furthermore, recovery has not been
uniform across the region. Mexico and Brazil have been the major beneficiaries, while the smaller markets have seen liquidity sucked out.
“Mexico has performed particularly well,” says Jane Heap at Deutsche Bank in New York. “The market has been the region’s out-performer, and the currency has been solid. Further, although there are primaries set for the new year, the element of political risk is much diminished.”
Mexico is remaining buoyant thanks to the ability of companies such as CEMEX and Grupo Mexico to compete like North American companies in their own sectors of construction and mining, she adds.
What Heap also sees as key is the willingness of governments to stick to the institutional reforms taking place across the continent, and to take a back seat with respect to economic management. Brazil seems set to benefit from this political commitment, with the IMF predicting a much softer landing than previously envisaged for the economy next year.
However, throughout the year there has been a liquidity crisis. Brazil was trading last autumn at $1bn-a-day; now that figure is down to between $200m and $300m. And that figure only represents a few large stocks, with little or no filter-down to the smaller issues. This is typical across the region, as recent selling pressure in the US equity markets has led to institutional money leaving Latin America, and heading north.
Aside from the big two, the smaller economies have suffered. Venezuela, Peru, Argentina and even Chile have seen liquidity sink. The glimmer of good news on the horizon, however, is the rise in commodity prices across the region.
In Chile, copper and pulp prices will benefit the economy generally and should contribute to recovery from the mild recession. Valentin Carril, at Banco Santander in Santiago, predicts GDP growth of 5.3% for 2000. “An improving trade balance, driven by a rise in exports has helped, but the main reason for optimism is the increase in commodity prices. At the beginning of the year, the fall in copper prices had a serious affect on the current account deficit and GDP
He expects Argentina to recover for similar reasons, but because of the lag on agriculture prices in the economy, it will probably improve more slowly, he believes. He predicts a 2% growth in GDP next year after a sluggish first quarter. Indeed, growth seems to be the story across the region, and if the final quarter of 1999 shows recovery as predicted, then investors may have an easier ride next year.
“Brazil has been the other key to the region,” says Carril. “Back in March, everyone was looking at a dramatic fall in GDP, but we are now predicting a drop of only 0.2%, with unspectacular but steady growth of 2.7% for next year."
The other major factor in Latin America is political stability. While Brazil has shown resilience in the face of last year’s crisis, other countries have not been so lucky. Columbia, in the grip of civil war and with exchange rate problems, is in a deep
recession, while the lack of political consensus in Ecuador is persuading some analysts to warn of a slump in GDP of up to 8%
next year.
But Carril believes there could be some serious growth in two of the smaller markets, again driven by rising commodity prices. “The recovery in oil prices should lead to a big improvement in the situation in Venezuela. We predict growth of 3.6% next year. Meanwhile, Peru has been recovering from the affect of El Nino in 1998 and the economy is already on an upward curve.
If the major gas project finally comes to fruition, GDP could improve by 4.5%
next year.”
Heap is also confident that next year will see growth returning to the region and the markets. “Interest rates look set to fall, and once the election smoke has cleared in Mexico I am sure we are in for a buoyant first quarter and more,” she says.
Fund managers are also keeping a weather eye on the political situation and, in particular, how keenly governments abide by the fiscal reforms which have been introduced across the region. The lesson of last year was that only countries that stick to the rules are likely to see growth spurred by the return of foreign investment.
Commenting on Brazil, Andrew Telfer, Baillie Gifford Latin America Fund manager, says: “I think fiscal balance is still the main concern. Some of the measures taken are of a temporary nature and will have to be made more permanent.” The implication being that the government is still involved in a juggling act to try to satisfy different interest groups.
Telfer agrees that Mexico and Brazil have done well this year in different and difficult circumstances. “Mexico has more or less de-coupled from the region due to its close connections with the US. Exports represent 30% of GDP and, of those, 90% are
destined for the North American market. The real success of Mexico has been that low oil prices in the past have encouraged a diversification of exports into the manufacturing sectors. Also, a slow down in capital in-flow, due to the Asian and Russian crises, has led to higher interest rates which has meant that the domestic economy has not over-heated.”
Turning to Brazil, Telfer feels that industry has not taken advantage of the large devaluation of the currency. “Although the flat or neutral year which Brazil looks like achieving is far better than the 5% contraction predicted in many quarters, exports have not really come through. Although they are a small percentage of GDP, companies have been slow to react to devaluation, and it has only been the reduction in domestic demand which has persuaded them to adopt a more aggressive attitude to exports.”
Indeed, analysts are disappointed with Brazil’s current account deficit showing of 4% of GDP after such a large devaluation in the Real.
Although funds tend to invest in countries rather than sectors across the region, there is no doubt that commodities play an enormous part in dictating where capital flows. “Although we tend to look at countries rather than sectors, as commodity prices fluctuate – down in 1998 and up again this year – we treat them more as a sector. The significance being that they account for some 20% of the stock listed in the region. Obviously, their value is the key to the success of the countries, companies and to the sentiment towards the region from overseas investors.”
Telfer also points to the dramatic fall in liquidity levels across Latin America as being a major worry. As he points out, it is not only because of a lack of confidence, or commodity prices. “Foreign corporate analysts see many of the companies listed in Latin America as underpriced, and with scope for development. Some of these larger companies account for a large part of liquidity on local markets. Once they are no longer listed, volume collapses.”
A good example of this, though by no means the only one, is the purchase of YPF, previously the Argentine State Oil Company, by Repsol.
Nevertheless, Telfer is confident about the region’s prospects for growth next year. “We expect growth to be around 4% for the region, spread a little unevenly. For example, Argentina could not devalue, being pegged to the US dollar, and will probably find growth difficult, meanwhile Chile has dropped interest rates dramatically and will be in a good position during the first quarter of next year.”
If the haemorrhaging of funds from the region can be stemmed, then prospects may begin to look better. Much will depend on events north of Mexico.
Although the sovereign debt markets continue to be negative for equities throughout the region, oil prices will underpin Mexico and help Venezuela’s recovery. A strong case has been made for Mexico’s equity market, and only a hard landing for the US economy could cause long-term problems.
There remains the worry, however, that investors will switch out of Latin America into other emerging markets, despite the strong showings of Brazil and Mexico. Across the region the markets need a faster turnaround in the macroeconomic environment, which could lead to a faster recovery in earnings, or a slackening of monetary policy. Political problems and the pace of fiscal reform in Argentina and Brazil, suggest
that optimism could be delayed until next year.
Although the equity market in Brazil is extremely cyclical and very attractive to many analysts on a valuation basis, fiscal reforms dog enthusiasm, as do worries about the determination of the government to stick to IMF guidelines.
As a result of regional worries, most other countries are downgraded to the end of the year, with Mexico’s defensive characteristics earning it a neutral rating. Most agree that a slow end to the year will mean that a strong first quarter and rally across the region will be crucial to renewed optimism in Latin America’s markets. Kevin Hall