While valuations were generally attractive and earnings remained resilient for the better part of 2011, the earnings outlook based on revision trends continues to worsen, particularly in developed markets. The secular outlook for emerging markets remains attractive, and the cyclical outlook has started to improve, driven by a shift away from restrictive monetary policies, stabilising economic growth, and earnings revision trends.
Despite global uncertainties, there are several factors working in favor of Latin America in 2012.
Accommodative monetary policy
Concerns about inflation dominated headlines in 2011, resulting in a continuation of restrictive monetary policy on the part of many Latin American Central Banks. Brazil had the highest inflation rate last year at over 6.5% with expectations this year for 5.5%.
Inflation for Chile, Colombia, Mexico and Peru were all more than 3%, with expectations for 2012 in line or slightly higher. As inflation fears have moderated, policy in Latin American should become more accommodative providing the framework for future economic and earnings growth.
Even if global risks increase causing growth to weaken, Latin America has the ability to use both monetary and fiscal policy to support domestic economies unlike many of the developed countries.
Attractive valuations
Increased volatility and an uncertain investment environment have resulted in a higher equity risk premium for Latin America, driving down stock prices. Valuations now look attractive relative to history and fair value.
Global Emerging Market (GEM) equity valuations are rarely this low. At 9.1 times forward earnings, price-to-earnings ratios are in the bottom decile of all observed valuations for the asset class, which include such observations as the Mexican crisis of the mid ‘90s, Russia and Long Term Capital Management in the late 90s, as well as the LatAm debt crisis and the tech wreck of the early 2000s.
This highlights just how low current valuations are, particularly considering the stronger fundamentals of GEM markets today. Most are investment grade with economic growth on an annual basis of 4-9%.
Macro and corporate fundamentals are in much better shape with little or no exposure to many of the problems in the developed world.
Any moderation in global uncertainty should witness Latin America along with other emerging markets rewarded for their better fundamentals and growth prospects.
Intra emerging market trade
Latin America is blessed with favorable demographics as a majority of the population is less than 30 years old. The median age of Brazil is 29.3, Chile 32.1, Colombia 28, Mexico 27.1, Peru 26.2 We will continue to see increasing disposable income as more and more people join the middle class.
Latin America has a relatively large middle class in comparison to China and India, where it accounted for only 3.8% and 2.8% of the population respectively in 2005.
The move into the middle class will be accompanied by increased demand for goods and services including commodities. This bodes well for the economies of Latin America as the dependence on developed market consumers abates in favor of local consumers. This in turn, lessens the impact of economic uncertainty in other parts of the world.
Reversal of flows
Total outflows from EM equity last year was about $34bn, close to the $40bn that was redeemed in 2008 at the height of the Lehman crisis. It is also in stark contrast to 2010 when we witnessed inflows of close to $85bn. We have seen inflows into GEM of approximately $7.5bn so far this year.
Investors still believe in the fundamentals of the asset class, however, they chose to forego equities in favor of debt as their preferred means of access. Any move back into risk assets would benefit emerging markets.
We remain cautious overall and expect the uneven, sluggish global expansion to continue in 2012. There is a risk that one or more of the major developed countries or regions will fall into recession. Emerging economies, including Latin America, are poised for soft landings as less restrictive monetary policies – in response to peaking inflation and slower global growth – remove a significant headwind.
