Headlines are rarely kind to Latin America: hyperinflation, currency crises, political and economic ...
Headlines are rarely kind to Latin America: hyperinflation, currency crises, political and economic chaos in Argentina and Venezuela. Thankfully, however, the returns to Latin American investors have been kind, primarily because many funds invest in companies not economies.
It is difficult not to admire Latin American companies. These are companies that have had to live through years of hyperinflation, devaluation, governmental price manipulation, sky-high real interest rates and recession/depression.
This volatile economic background means that the cost of capital is high. Consequently, many of our companies live in cosy duopolies as potential competitors find the cost of raising capital prohibitively expensive.
A benign competitive environment and fear of the economic unknown means that corporates tend to have strong cashflow and solid balance sheets (in contrast to many of their western counterparts).
The key to the region is Mexico, which now behaves like a developed economy. Last year, the economy slowed quickly as the US fell into recession. Consequently, the central bank reduced interest rates.
Historically, such a slowdown would have been accompanied by a currency crisis and a jacking up of interest rates. By joining the North American Free Trade Area (Nafta), signing trade agreements around the world and becoming a low cost re-export base, Mexico has become a magnet for productive foreign direct investment (FDI), which has supported the currency and allowed real interest rates to fall.
Historically, such capital flows would have been wasted: this time the government's tight fiscal and monetary policy has been so impressive that even S&P has upgraded the country to investment grade status. Ironically, the US slowdown has played into Mexican hands: for US manufacturers with no pricing power there is an easy way to reduce costs on their doorstep.
Before we get carried away, there is always Brazil. It is easy to be bearish: an old school socialist is doing well in opinion polls for October's presidential election, corruption scandals are brewing and a whiff of populist sentiment permeates the air.
Brazil's debt burden means it remains susceptible to the whims of global capital markets; not enough FDI has stimulated an export base and it needs to travel further along the Mexican route.
If we step back a bit, however, it is easy to be bullish: in the past 10 years, Brazil has moved from a fixed to a floating exchange rate, hyperinflation to 6% inflation, and fiscal deficits to primary fiscal surpluses. State industries have been privatised and a fiscal responsibility law passed to keep tabs on recalcitrant politicians.
Brazil's market has fallen 19% to date this year and valuations are becoming compelling for any one with an investment horizon greater than tomorrow morning.
Brazil will be volatile this year: investors do not like uncertainty, and no doubt headlines will be scary. But then again, headlines give investors opportunities.
Mexican convergence with the US.
Mexican earnings geared to US recovery.
Low valuations in market.
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