While the world is adjusting to ‘higher for longer’ interest rates, there is one region that is moving in the opposite direction: Latin America. Brazil, Chile and Peru have already dropped rates, with other central banks in the region likely to follow suit. Does it suggest an opportunity in the region? Or have the easy gains been made?
Latin American central banks are well-versed in dealing with inflation. They were among the first to recognise the severity of the inflation shock and to start raising rates. The Brazilian central bank was typical, starting to hike in March 2021, around a year ahead of the US Federal Reserve. At their peak, rates reached an eye-watering 11.25% in Chile and Mexico and 13.75% in Brazil.
This means inflationary pressures have ebbed more quickly than elsewhere and central banks have more flexibility. The Brazilian central bank cut rates by 0.5% in August and another 0.5% in September. It has signalled more cuts in the months ahead as long as inflation continues to fall. Chile lowered its borrowing costs by 0.75% to 9.5% in September, after a 1% cut in July. Another 0.75% cut is forecast at the next meeting.
Until recently, this has already been reflected in stockmarkets across the region. The Brazilian Bovespa rose 15% between January and July, while the MSCI Chile index also saw a sharp rise. This has been seen in the performance of specialist Latin America funds: the BlackRock Latin American investment trust is up 11.7% in share price terms for the year to date, while the average Latin American open-ended fund is up 7.6%.
Share prices have been more fragile recently, suggesting that any rally associated with rate cuts may have already happened. That said, it also means that valuations still look relatively cheap. For example, the NAV for the BlackRock trust is up 22.1%, but the share price rise has lagged by around 10%. The MSCI Latin America index trades on a forward p/e of 8.4x compared to 15.5x for the MSCI All World and 11.6x for the MSCI Emerging Markets index.
There is also the thorny question of Mexico. Mexico is going through an ‘extended pause’, keeping interest rates at 11.25%. The country is more closely tied to the fortunes of the US economy, which means inflation has been higher for longer, and it has been more difficult to lower rates. Most analysts expect the central bank to start cutting early in 2024, though recent comments from the central bank deputy governor suggest it may be later.
While Latin American economies have a tailwind from rising rates, there is no guarantee that this will automatically translate into higher economic growth and/or further rises in the stockmarket. The IMF is forecasting growth of 1.6% for the region in 2023 and 2% in 2024, though Argentina’s weakness is a drag on the regional average. It says: “Key external downside risks include lower growth in main trading partners, commodity price volatility, new inflationary shocks, renewed turbulence in financial markets of large economies, and the intensification of geopolitical tensions. At the regional level, downside risks include a re-emergence of inflationary pressures, increased social tensions and violence, and climate-related shocks.”
Oxford Economics sees political instability and social unrest brewing in the region after an uneven recovery from the pandemic. It adds: “The lower support from commodity prices and tighter monetary policies than in advanced economies will also drag on growth even if central banks in the region start to loosen their grip.”
There are some positives, the IMF believes the region may benefit from an improving global economy, a faster-than-anticipated decline in inflation, less scarring from recent shocks than previously envisaged, and growth in green minerals and energy sectors. Energy prices have started to rise again since the start of the summer and Latin America is seen as a politically neutral supplier of fossil fuels. This may help boost growth.
Equally, Mexico looks set to be a natural beneficiary of the trend among global companies to bring production nearer to home. Its proximity to the US makes it an obvious choice for international companies looking to move. In a recent research report, Oxford Economics says: “Mexico is the emerging market with potentially the greatest to gain from the trade decoupling between US and China.” Since 2017, Mexico has surpassed Canada to become the US’s largest trade partner after China. The country, along with a number of other Latin American countries, has a demographic dividend.
The region also has plenty of appealing companies. While commodities are still a large part of the MSCI Latin American index (around 31% of the index is in the mining and materials sectors), there are a growing number of interesting technology and consumer discretionary companies in the region, taking advantage of the region’s growing middle class – Mercardo Libre, for example, or Pagseguro, the Brazilian payments acquirer.
However, Latin America still struggles from a ‘so what’ problem. It is a tiny part of the MSCI Emerging Markets index: Brazil is just 5.4% and is double the weighting for Mexico. For example, Prashant Khemka, manager of the Whiteoak Emerging Markets fund, has a small overweight position – 10.4% compared to 8.8% for his benchmark – and says he is ‘neither positive nor negative’. He has some selective exposure to Mexico, through companies such as Qualitas Controladora, but finds more opportunities in India and China.
BlackRock says the region may garner greater attention because it is relatively isolated from global geopolitical conflicts, suggesting this could lead to both an increase in foreign direct investment and an increase in allocation from investors across the region. This is likely to be a slow burn. The region compares relatively favourably to other emerging markets, but it is still struggling for attention against its Asian peers.
