abrdn’s Figueiredo on outlook for Latin America

by | Jan 19, 2023

Eduardo Figueiredo, director, head of Brazilian equities, abrdn shares his thoughts on the outlook for Latin America:

Latin America has a reputation for difficult politics and 2022 brought elections to Brazil and Colombia, plus a referendum about the constitution in Chile, that may, despite the initial turbulence, usher in a period of relatively lower political volatility as we enter 2023.

Despite the challenges, the region ended the year among the top-performing equity markets, demonstrating that the support from valuations, earnings recovery and the cyclical component of the Latin America benchmarks worked well. 

Going forward, we see these attributes as valid, and valuations continue to point to a positive asymmetry. However, we remain vigilant on the developments within the region, especially around the policy direction from the new government in Brazil and the fluid political environment across the region, which will continue to weigh on sentiment and challenge convictions.

 

Brazil

In Brazil, the election of a left-wing president, Luiz Inacio Lula da Silva, and the defeat of far-right incumbent Jair Bolsonaro, had been broadly expected.

Concerns around a disputed outcome and institutional instability are beginning to diminish, so investors are now turning their attention to cabinet appointments and hints as to policy direction. Investors have been surprised by the initial proposals around fiscal expenditure from the new government, as these could undermine the trajectory of public debt consolidation and create unfavourable conditions for the start of an easing cycle in 2023. This negative response was particularly visible in the sharp reactions in the local yield curve since November.

 We are closely monitoring developments and keeping a cautious view until there is more clarity on whether a balanced Congress can enforce pragmatism on the Lula administration, which would pave the way for a conducive scenario for investments. Support for centre-right parties in Brazil’s Congress could potentially reign in the ambitious spending plans Lula and the Workers’ Party have to expand social welfare, raise taxes and reverse privatisations.

The Brazilian economy is currently in a stronger-than-expected position.  The central bank hiked rates decisively and has brought inflation under control. The commodities-rich economy is doing better than expected and has falling unemployment, and the new president has pledged stronger environmental protections, which should attract ESG-aligned foreign investment.

Lula is willing to put Brazil back on the global stage in the climate debate, in terms of repositioning the country not only as a natural resource base, but also as a powerhouse of renewable energy. This could be positive for Brazil and for agricultural companies. The new government also aims to do more social spending in education and lower-income housing, so companies exposed to these sectors could benefit. 

However, the country is not immune to the pressures facing the global economy and is likely to slow in 2023.

 

Mexico

There was a change of government in Mexico three years ago, with Andres Manuel Lopez Obrador becoming president. At the time, as he was expected to be hard left, we saw investments contracting in Mexico and leading to uncertainty and a discount in valuations. But this situation is turning around.

Currently, the currency is strong, and fiscals are strong with the country’s central bank hiking in line with the US Federal Reserve. An estimated 6% of GDP is made up of ‘remittances’, money that Mexicans abroad, typically in the US, send home to their families. These remittances have grown with the jump in US labour inflation. Plus, tourism, Mexico’s major industry, has seen a strong rebound.

With the new North American Free Trade Agreement, ties between Mexico, the United States and Canada, have been strengthened. The big story for Mexico is the post-Covid ‘near-shoring trend’ which aims to resolve supply-chain issues and the cost of shipping by manufacturing closer to home. Mexico is a big manufacturing hub with attractive wage levels, bordering the US. Industrial rentals are up 20% and vacancy rates are low. The government is promoting near-shoring and registered exporters may be given a ‘softer border’ with the US. Historically, the country was known for its car industry, but technology companies are now moving in too.

 

Chile, Peru, Colombia

There has been a significant swing to leftist parties in these countries, but the reality has not proved to be as dramatic, although the situation is currently volatile in Peru. Generally, the left in Latin America focuses on better public services and more inclusive growth. 

Under their left-leaning governments, Chilean and Colombian economies have continued to grow. Sensible finance ministers have been appointed, giving markets confidence. Colombia’s tax reforms have been designed not to discourage much-needed investment.

 

Overall

Central banks in the region have acted quickly to raise interest rates and curb inflation, ahead of the US Federal Reserve. Some countries are moving to disentangle the corporate sector from the state to attract more investment. These initiatives are building greater resilience at the heart of Latin American economies.

Certainly, oil prices have come down and oil companies are expected to make less profit in 2023. On the consumption side, companies that have focused on efficiency are well positioned to deliver good earnings, especially if the region stabilises interest rates, having moved more quickly to control inflation pressures. Inevitably, higher interest rates will start to put pressure on corporate earnings. 

Latin America is more insulated against a stronger US dollar, as exposure to commodities means exporters ultimately benefit. The region is a natural resource base, one of the leading producers of copper, which will be needed for energy transition and electrification trends.

Brazil is a major agricultural and energy producer and is positioning itself as an alternative to Russia or Ukraine. When inflation is high globally and there are challenges around the supply of natural resources, then Latin America stacks up well.

The region has outperformed the wider emerging markets space for the past year, but in absolute terms performance has been weak and valuations remain low. However, there is a pool of quality companies with solid balance sheets here that should be able to withstand the current challenging environment and thrive over the medium and long term. 

 

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