There Have Been Challenges Including Rising Interest Rates And Political Tension In Brazil, Argentina And Peru
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Latin America is endowed with abundant natural resources, a growing population, and proximity to the vast American consumer market. The MSCI Latin America Index has performed better than the MSCI Emerging Market Index cumulatively over the past five and seven years as well as over longer time periods, buoyed by its natural resource companies. We have identified three themes that we believe are likely to drive continued performance in the years ahead:
• Supplying the renewable energy revolution. The region is well placed to take advantage of the opportunities created by the renewable energy revolution with 54% of global lithium reserves concentrated there. Latin America is also the leading producer of copper, and iron ore.
• Nearshoring and increased US trading opportunities. Mexico is a beneficiary of the China+1 strategy, where manufacturers add additional production capacity outside China. It can also benefit from the United States-MexicoCanada (USMCA) agreement and the US Inflation reduction Act (IRA).
• Consumption. Surging demand for commodities globally has boosted exports and created a trickle-down effect in the region, expanding the middle class while driving financial deepening and increasing demand for consumer goods.
The investment opportunity
Latin America is home to 650 million people spread across 20 countries. What distinguishes the region from other emerging markets is its access to resources. The region produces almost 40% of global copper supply and is home to four of the world’s largest reserves of lithium, with Chile accounting for half of total reserves.The region is also a major energy and agricultural commodity exporter.
From an investor perspective, the region offers access to some of the leading global resource companies as well as access to beneficiaries of the strength in domestic demand. These include iron ore producer Vale, oil explorer Petrobras and copper miner Grupo Mexico (via Southern Copper). Companies with exposure to domestic demand include the banks Grupo Financiero Banorte, Itau Unibanco, as well as consumer companies including Fomento Económico Mexicano, Kimberly-Clark de Mexico, Wal Mart de Mexico and Ambev.
Valuations
The region historically trades below developed market valuations but has higher corporate margins and return on equity. These attractive fundamentals, in combination with the rise in commodity prices and resilient domestic demand over the past two years, have driven market performance.
Politics and policies
Within this positive backdrop, there have been challenges including rising interest rates and political tension in Brazil, Argentina and Peru. Nevertheless, the successful transition of power in the region’s largest economy, Brazil, is a positive signal for governance, noting the political stance of the new government has turned to the left. Investors have been willing to separate the internal political events from economics, as reflected in the stability of currencies including the Brazilian real and Mexican peso.
Monetary policy in the region has been more proactive in tackling inflation compared to developed markets (DMs). Brazil raised interest rates as early as March 2021, 12 months earlier than the US Federal Reserve, with rates rising by a cumulative 11.75% to reduce inflation. This is likely to pay dividends in 2023 as policymakers pivot to cutting rates as inflationary pressures ebb.
The prospects for growth in Latin America are closely linked to commodity prices. Using the example of high commodity prices between 2007 – 2014, there was a significant increase in investment during the period, which stimulated economic growth. While oil prices have declined from their early-2022 highs as DM growth slowed, they are expected to remain elevated. Metal and agricultural commodity prices are also expected to remain buoyant, driven in part by supply issues stemming from Russia’s invasion of Ukraine. This is expected to boost investment and support growth across the region, particularly in Brazil and Chile.
