Article by Andrés Acevedo Vergara is Executive Director of Traditional Assets at SURA Investment
For fear of stating the obvious, we all know that markets move in cycles and, as an emerging market, Latin America is a high beta market. It is certainly a risk for a European investor – mainly from a short-term perspective in my opinion – but a risk nonetheless. However, I would like to highlight the long-term relative advantages that LATAM offers that clearly outweigh any short-term risk. But let us first take a little detour around the world to gain some perspective.
Factors underpinning uncertainty
There is little doubt that we are entering a long-term phase of sluggish global growth, one predicated by unfavourable demographics in most developed economies, and in the largest emerging one, China. This is significant not only because of a lower proportion of working age population, but because these economies will move from a scenario of high capital availability to one of higher capital constraints. This will unfold as the older generations retire and start depleting a capital base that had previously been available to their respective economies.
But demographic concerns are not the only headwind that the global economy faces. The fact that the monetary policies which have fuelled extraordinary growth over the past 40 years are largely depleted provides a much shorter-term challenge as we enter the tenth year of a global bull market that started in 2009. Today, policy rates stand at zero or negative levels in Japan, the EU, Switzerland, Denmark and Sweden, with the UK and the US not much higher. All against a backdrop of never-ending quantitative easing in Japan, and a restart of balance sheet expansion at the ECB and Federal Reserve System.
Finally, many government debt levels are above 100% debt to GDP and rising, and in the case of Japan, way over 200%. Again, China needs mentioning here, because total debt to GDP is above 300%, materially above usual levels for a country with similar levels of development.
Under this gloomy outlook, the world might be looking to Asia as the engine of growth. But the long-term geopolitical struggle between the US and China, which has materialised as a trade war, will to some degree hinder this. Furthermore, unfavourable demographics in China put a dent in Asia’s otherwise relative strengths in this area.
So, we are left with Eastern Europe, a region that continues to have rule of law concerns; the Middle East, which is plagued by geopolitical struggles; and Africa, which despite enormous potential, still has many question marks hanging over it in terms of governance and infrastructure.
Look to Latin America
Which brings us to Latin America, specifically the Pacific Alliance of Mexico, Chile, Colombia, Peru and Brazil. These five countries offer an underutilised long-term opportunity for the European investor. First, their favourable demographics structurally support the development of consumption-based growth patterns. Most of these economies have a significant link to the commodities market (Mexico being the exception) but the region has learned from past mistakes and today free-floating currencies make the bulk of the required macro adjustments. To complement this point, it is relevant to consider that for the main equity indices, commodity stocks represent only 18% for the Pacific Alliance markets and 25% for the whole of Latin America, with the other 82 to 75% being made up of companies much more related to internal dynamics than global fluctuations in commodity prices.
Additionally, fiscal responsibility – not the most common trait of Latin American governments – is slowly becoming an integral principle among these five countries, and has been implemented by both left- and right-leaning administrations for the bulk of the last two decades. Consistently, debt levels are lower, ranging from 25 to 50% of GDP on a gross basis for the Pacific Alliance economies, with Brazil being the only one with higher debt levels. But the recent approval of the pension reform and the right-leaning government of Jair Bolsonaro should reign in the poor debt dynamics that have been observed during the last decade in Brazil. So, under this scenario and considering the global search for yield, the region offers opportunities in corporate credit both on local and hard currency in well-managed companies with sustainable debt levels and positive long-term prospects.
Finally, in this world of trade wars and the US’s disengagement from global affairs, it must be noted that beyond Trump’s stance against Mexico, Mexico’s manufacturing base naturally complements the US’s consumption-based economy. This is a fact that is often overlooked, but has been made evident by a relatively fast resolution of the NAFTA dispute – which is in contrast to the seemingly intractable dispute between China and the US. A dispute that might well be a tailwind for Latin America, and Mexico in particular, for decades to come.