Written by Ed Kuczma, co-manager of the BlackRock Latin American Investment Trust plc.
- Latin American markets are benefiting from a global move towards ‘value’ companies, which favours areas such as energy and financials.
- Rising commodity prices have driven Latin American stock markets higher since the start of the year, in contrast to many of their emerging market peers1. Higher commodity prices are also having an impact on the region’s currencies, which have performed well after a dismal year in 2021.
- The political landscape is mixed, with promising signs of a more moderate government in Brazil, but high tax and spending governments elected in Chile and Peru
Rising commodity prices
Rising commodity prices are generally good for Latin American markets and 2022 has proved no exception. The prices of oil, soybeans and iron ore, Brazil’s main commodity exports, have increased since the start of the year. Mexico is a beneficiary of higher oil prices, while Chile and Peru make up 30% of production for in-demand copper. This has undoubtedly helped spur Latin American stock markets since the start of the year.
There is also a strong outlook for pulp and paper, with resilient demand. A lot of new capacity has been delayed, as a result of the pandemic and disruption in supply. This is pushing up prices. Latin American companies are among the lowest cost pulp and paper producers in the world, which gives them a significant advantage at a time of rising prices.
However, it is not all one way. Brazil is also a major exporter of grain, and the lack of fertiliser – which is usually imported from Russia and Ukraine – is a significant problem. This may dent exports in the year ahead. Equally, inflation has hurt across Latin America, particularly in the consumer discretionary sector. If people are paying more money for energy supplies, they have less to spend on consumer goods.
Latin American currencies
The demand for commodities is having an impact on the region’s currencies, reversing a dismal performance in 2021. Investors are learning to live with the region’s political risk, focusing instead on soaring local interest rates and commodity prices. Brazil, Chile and Peru are the top three performing emerging-market currencies this year, a sharp turnaround from 2021 when Latin America represented four of the six worst performers.
Latin American central banks were the first to raise rates last year and policy makers in Chile and Colombia have both surprised markets with steep hikes this year in preparation for Federal Reserve tightening. Brazilian policy makers have increased borrowing costs to 12.75%, the highest in almost five years1. This has seen international investors gravitate to their currencies in search of higher yields (the ‘carry trade’).
However, even after their recent rally, Latin American currencies remain cheap relative to the rest of the world and a more benign political climate could encourage more investors towards Latin American currencies and markets.
It’s a big year ahead in Latin American politics, with elections in Brazil. Luiz Inácio Lula da Silva (‘Lula’) is the front-runner. He has given even clearer signs that he will choose business-friendly Geraldo Alckmin as his running mate, indicating he would govern as a moderate. This is encouraging investors in the region.
However, politics in the region is not all one-way. There are emerging risks in countries such as Chile and Peru, which have elected left-leaning, higher taxing governments. This could squeeze consumer spending at a vulnerable time for households. They have also set their sights on the mining sector as a target for taxation, which they see making higher profits. This may make it tougher to bring on the new capacity badly needed to meet demand.
Even after the recent rally, the Latin American indices are under-owned and under-valued. Latin America has benefited at the margin from some of the flows leaving Russia and greater foreign capital has come into the region. There had already been some redeployment of capital away from China following the weakness in the Chinese technology sector in 2021.
The region is also benefiting from the move towards ‘value’ stocks. Around 60% of the Ibovespa is made up of stocks often classified as value (mostly financials and commodities), and this compares with around 15% in the S&P 500. Other Latin American countries (Chile, Colombia and Peru) also have a strong value bias. Growth stocks remain unloved but uncertainty on the Fed’s pace of interest rate rises may keep investors away from growth stocks for now.
The underlying forces behind the recent rally show no signs of fading. For example, Brazil’s high yields compared with peers and relatively cheap local stock markets continue to attract foreign account inflows.
In the Trust, we have sought to take advantage of rising commodity prices with a relatively high weighting in the materials sector, including groups such as Vale, Petrobras and Cemex. Our largest position is in financials, which are a key beneficiary of the rising rate environment. Higher rates should allow them to raise margins. Valuations are still low for the banking sector in the region, while return on equity is high.