Latin America enjoying sharp rally
Latin American equity markets showed a very high correlation with Nasdaq through the first quarter o...
Latin American equity markets showed a very high correlation with Nasdaq through the first quarter of 2000. This despite underlying economies which are anything but new world. It might appear that there would be little here for the dot.com frenzy to feed off. The markets are dominated by natural resources, banks, cement, brewers and utilities. However, the missing industry from that list is telecommunications, seen as the perfect vehicle to access rising IT spending and growing internet use in the region.
As technology stocks rose worldwide, Latin America enjoyed a strong start to the year. The Latin component of the MSCI Emerging Markets Free Index had gained almost 10% by the end of February. Since early March, however, equities have given all this back and more, down 8% in the four months to the end of April.
The focus on technology has all but ignored the fact that there is a sharp economic recovery in the major Latin American markets. Regional GDP growth is expected to be 3-4% this year, albeit from a low base. Indeed, recent data from Brazil and Mexico may prove this estimate conservative.
Despite this strong cyclical recovery, we maintain our long-held cautious view on Latin American equities. On the macroeconomic side, the region remains the most dependent of all emerging areas on external capital, particularly from the US. This financing gap can cause significant volatility as sentiment shifts. This liquidity squeeze has damaged stock markets twice in recent years; first in Mexico in 1995 and then in Brazil late in 1998 prior to the ultimate devaluation of the real. We see little reason for a negative shift short-term, but suggest that Latin American market ratings always bear some risk premium.
In Brazil, the long-term imbalance that stems from low savings rates and a fiscal deficit continues to cast a cloud over the cyclical recovery of the last 12 months. While this recovery has provided respite, this could well prove temporary, as there has been little evidence of genuine structural reform.
The second major concern we have had with the region over the longer term is more problematic - a conflict with our fundamental investment style. We are primarily stock-pickers and as such have never invested in a particular region if we have not found compelling investment opportunities. In the context of this strategy, Latin America has proved less fertile territory than elsewhere, with relatively few competitive, world-class companies outside natural resources and basic industry.
As these economies develop, much of the foreign direct investment has been aimed at subsidiary operations of multinationals, rather than developing globally competitive Latin-based businesses.
There are exceptions. Grupo Modelo, brewer of Corona, the largest-selling imported beer in the US, or Cemex, the third largest cement company in the world, are two Mexican companies which we have held for some time. In Brazil we hold Aracruz and CST. This focus on natural resources and basic industry extends to Chile where we hold Antofagasta, the world-leading copper producer.
Stuart Paul is joint head of global emerging markets at Colonial Stewart Ivory
