Noise and reality in Latin American markets

Ed Kuczma, Co-Manager of the BlackRock Latin American Investment Trust plc, believes valuations may have moved out of step with reality in hard-hit countries across the region.

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This has not been an easy time to be an investor in Latin America. The way Brazil, the largest country in the region, responded to the coronavirus crisis created economic and political disruption. Mexico has suffered for its dependence on oil. And, while the impact in countries such as Chile and Peru, has been far less profound, in aggregate, the region has suffered.

This has hit stock markets hard. The benchmark Brazilian index, the Bovespa, was down around 50% at its weakest point1, from already cheap valuations. The decline in Mexico has been less severe, but the index remains below its level in March2.

However, we believe this weakness may have been overdone. When we look at the previous lows, the market has often found its floor long before economic or political conditions improved. The MSCI Emerging Markets Latin America index saw a low in February 2009, when the region’s economies were in the mire following the Global Financial Crisis and a period of Dollar strength. Mexico’s economy, for example, slipped 5% in 2009, with inflation running at over 5%3.

The index saw another significant trough at the end of 2015. This coincided with the impeachment of Brazilian president Dilma Rousseff and a scandal at the country’s largest oil company. The Brazilian state was rudderless until Rousseff finally left office in mid-20164.

Valuations over politics

However, in all of these instances, the political and economic climate mattered little. It was valuations that turned the tide for the region. Markets didn’t turn because the climate got better, they turned because valuations hit a floor.

Today, we see many of the same conditions. As it stands, Brazil makes up just 5% of the MSCI Global Emerging Markets index5. This is less than the largest individual technology giants in China5. Brazil is the ninth largest economy in the world by GDP, Mexico the fifteenth6. The region is widely neglected by global asset allocators and investors.

This is also seen in the valuation of individual companies. While price to earnings is a relatively crude tool to assess relative value, as a guide, US companies trade on an average of around 17x price to earnings, while Latin American companies trade on an average of around 11x. While many Latin American companies face a difficult time ahead, there are still many globally competitive companies with visible income streams in areas such as telecoms and ecommerce that have also been knocked back where valuations look compelling.

Policy action

While headlines may, generally, be negative at the moment, it is worth remembering that countries in the region are using monetary and fiscal policy levers at their disposal to pull themselves out of their economic difficulties. Capital Economics suggests that the easing cycle may have further to run in Brazil, Mexico and Colombia in spite of meaningful cuts already7.

Equally, the pressure on currency is easing. Initially, there was a flight to quality for the Dollar and a significant portion of the decline in Latin American stock markets was down to currency depreciation8. However, this has eased. The Dollar is no longer seen as ‘safe’ as the infection rate fails to consistently decrease in the US. At the same time, the Brazilian Real has recovered some ground on the assumption that the central bank will continue to cut rates9.

In previous crises, Latin American economies have bounced back strongly. After the Global Financial Crisis, Brazil saw GDP growth of 7.5% in 2010, Mexico rose 5.1%, and Chile climbed 5.8%10. While this crisis is different in scale and scope, there are plenty of areas within Latin American economies still firing on all cylinders: agriculture, for example, looks set to benefit from higher demand for consumer staples. Other commodities may also be in demand as China goes back to work. In fact, early signs of recovery are already there.  In early June, MSCI Latin America had recovered 53% from its lows11.

At times of crisis, there is often an over-reaction. These markets are thinly traded and can be blown about by international sentiment. However, we believe they look increasingly out of step with the real prospects for the region. Times are hard, but markets are only starting to reflect the potential for a significant recovery.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy.

1 Market Watch, June 2020
2 Bloomberg, June 2020
3 IMF, April 2020
4 The Guardian, Aug 2016
5 MSCI, June 2020
6 World Population Review, July 2020
7 Capital Economics, June 2020
8 FT, May 2020
9 Merco Press, June 2020
10 IMF, April 2020
11 MSCI Latin America, June 2020

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