Latin American equity markets lead emerging markets

Latin American equity markets are among the best performers in the world’s emerging markets, even though they are plagued by political and financial turmoil.

Managers expect the countries to continue to do well because of improving economic growth, rising commodity prices, a resumption of capital flows to the region, a weak U.S. dollar and relatively cheap valuations.

The MSCI emerging markets free Latin America index was up 19.26% in US$ terms in the year-to-date period ended June 3, outperforming the overall MSCI EMF index’s 8.94%. Latin America also outperformed the emerging market universe over the 10-year period ended June 3, with a gain of 2.03% vs a loss of 1.09% for the lot. “The overall picture is one of a region that is starting to grow in 2003 and is likely to grow faster in the latter half of this year and into 2004,” says Thomas Trebat, managing director, Latin America economic research, at New York-based Salomon Smith Barney Inc.

Colleague Geoffrey Dennis, Latin American equity strategist, expects “a good year for Latin American equity markets in 2003, the best since 1999.” He believes returns from the region should increase as risk appetite rebounds and global growth expectations improve later in the year, a period during which Latin America should outperform other emerging markets.

Regional growth, forecast at 1.4% for 2003, is expected to more than triple next year to 4.4% (see chart).

The risk of investing in Latin America is relatively high, but for now the rewards may very well justify the additional risk. Here’s a breakdown:

> Venezuela: Despite a crippling oil workers’ strike this year aimed at removing unpopular President Hugo Chavez, the country is in a good position to lead regional growth in 2004, although it is forecast to be the worst-performing economy this year. It is experiencing a rapid recovery in oil production, reinforcing its ability to meet its debt-servicing obligations. Its market has been the best performer in the region for the year-to-date period, with a gain of 43.56% in US$.

> Argentina: Economic recovery is on track on all fronts, following an extended financial crisis precipitated by the country’s default on its international debt. However, political uncertainty remains at the forefront. In May, former Argentine president Carlos Menem abandoned his candidacy for the presidency, leaving the only other candidate, Nestor Kirschner, unopposed to replace caretaker President Eduardo Duhalde.
Whether Kirschner will lead Argentina to prosperity remains up in the air, but so far indications are positive as the Argentine market is up 36.17% for the year.

> Brazil: Although economic growth is sluggish in Brazil, the region’s largest economy, the market is up 25.9% for the year, fuelled by expectations of a pickup in growth, promises of tax and social security reforms, increasing flows of private capital, a shrinking current account deficit, greater central bank autonomy and confidence in the government.

> Mexico: Traditionally, the region’s safe haven, Mexico remains dependent on a recovery in the U.S. Up a modest 11.2% for the year, the Mexican market is the worst-performing in the region so far.
Government policy is focused primarily on reducing inflation expectations and stabilizing the peso rather than economic stimulus, says Trebat. “In addition, Mexico is beginning to lose traditional outsourcing contracts to countries such as China that offer lower wages, skilled workers and quality manufacturing capability, adds Craig Millar, international equity analyst, Altamira Investment Services Inc., in Toronto.

> Chile: Its market remains dependent on a recovery in global growth, improving copper prices and stronger domestic demand.
Although Chile signed a free trade agreement with the U.S. this year, its failure to back the U.S.-sponsored resolution in the United Nations to attack Iraq is expected to cool relations between the two countries.
Chile suffered a rare setback a few months ago with a central bank scandal that involved a leak of confidential information and the fraudulent issuance of certificates of deposit by a state-owned financial institution.
Although the central bank’s president resigned over the scandal, it is expected to have at least some impact on the economy.

> Peru: The country led the region in growth last year and now, fuelled by rising exports, higher commodity prices, expanding domestic demand and improved tax collection, it is expected to remain strong.
Although the country is not generally affected by external shocks, fears of political instability remain high. In late May, President Alejandro Toledo declared a 30-day state of emergency following violent strikes and protests from a wide cross-section of workers calling for higher salaries, lower taxes and import protection.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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