"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

Stock-picking key to investing in Latin America and Eastern Europe

Stock-picking key to investing in Latin America and Eastern Europe

Emerging economies in Latin America and Eastern Europe will face a challenging 2015, with wide divergences and no clear consensus among portfolio managers in the outlook for countries in these two regions.

For example, Paul Taylor, chief investment officer with BMO Global Asset Management Inc. in Toronto is “modestly bullish, with a bit of trepidation” on these regions. On the other hand, Christine Tan, portfolio manager with Excel Investment Counsel Inc. in Mississauga, Ont., has “more of a negative bias” on these regions as a whole.

“The overhanging stressors” on these regions’ economies, says Matthew Strauss, global strategist and portfolio manager with CI Investments Inc. in Toronto, “are low commodities prices and a tricky macroeconomic environment.” He adds that geopolitical risks in Eastern Europe will also weigh on countries in that region.

One of the key determinants of the outlook for Latin America and Eastern Europe is lower oil prices. Managers agree that net oil importing countries such as Turkey, Peru and Chile will benefit from lower import cost for oil but exporting countries such as Russia, Venezuela, Colombia and to a lesser extent, Brazil and Mexico will be hurt by declining oil revenues.

The decline in gold and base metals prices will also hurt exporting nations, especially countries in Latin America. A potential rebound in commodities prices, although unlikely, will be dependent on the extent of the global economic recovery.

Given the divergences in the outlook for Latin America and Eastern Europe, Taylor says these regions “will follow a two-tier growth rate.” That is, growth in Latin America which is dominated by commodity exports will be weaker than in Eastern Europe which is a commodity importer.

Nevertheless, although Eastern Europe will benefit from lower oil prices, the risk of deflation spilling over from developed Europe runs high. In fact, “deflation has already spilled over into the region,” Strauss says. “Hungary already has negative inflation, while the Czech Republic and Poland are trying to stay above zero.”

Michael Greenberg, vice president and portfolio manager with Franklin Templeton Investments Corp. in Toronto is a little more optimistic: “The credit cycle is improving and banks are willing to lend. [I don’t] see the Eurozone area heading fully into deflation.”

Apart from economic factors, geopolitics is also dampening growth in Eastern Europe. In particular, “Russian sanctions are a big negative overhang,” suggests Strauss, who believes that “[Russian President Vladimir] Putin’s ambitions have cast a dark cloud over the region, with many countries exporting to Russia heading into recession.”

Incidentally, the European Union is Russia’s largest trading partner. This has spurred “negative sentiments over the broad [regional] economic recovery that was supposed to occur,” Taylor says.

When deciding where to invest “it is, therefore, extremely important to understand the macroeconomic differentiation among markets,” says Tan, who focuses on “core secular themes that are independent of the underlying economic cycle,” such as health care and education, with selective bets on consumer stocks.

She adds, “domestic consumers in commodities-producing countries will be a little more muted,” says Tan, whereas consumers in oil-importing countries will benefit from lower prices, providing them with more disposable income.

Secular plays, says Taylor, are also benefitting from “urbanization, which is raising the standard of living” in emerging markets.

He suggests that “valuations are in favour of emerging markets” but there is “no huge momentum.” He will be staying away from commodity producers which will languish on the back of lower prices; favours consumer discretionary and industrials which will benefit from demand for goods and services; is neutral to financials which will remain relatively stable and underweighted in non-cyclical stocks which have no huge upside potential.

 

LATIN AMERICA & EASTERN EUROPE TRADING AT A DISCOUNT
Price/Earnings Price/Book
Regions/Countries Consensus 12-Month Forward 10-Year Historical Average Current Trailing 10-Year Historical Average
World 15.0 13.4 2.2 2.0
Emerging Asia 10.8 11.6 1.5 1.8
Emerging Markets 10.3 10.9 1.5 1.8
Latin America 11.8 11.1 1.6 2.0
Argentina 7.5 8.9 1.6 1.6
Brazil 9.6 9.7 1.3 1.8
Chile 14.2 16.1 1.7 2.1
Colombia 13.1 14.2 1.6 1.7
Mexico 18.2 14.3 2.9 2.7
Peru 13.3 12.0 2.2 3.2
Emerging Europe 5.2 8.1 0.9 1.4
Russia 3.2 7.0 0.6 1.3
Turkey 10.0 9.6 1.6 1.6

Source: J.P. Morgan, November 18, 2014

 

In spite of the outlook for the various countries, regions and sectors, managers are largely taking a stock specific approach to investing in Latin America and Eastern Europe.

In Latin America, Mexico is the favourite country among managers. It is a “good growth story” buoyed by “reforms in the energy sector [although] the government still has to deal with popularity problems which has cast a shadow over the macroenvironment,” says Strauss. Mexico will also benefit from the strength of the U.S. economy, as that country is the largest importer of Mexican goods.

Greenberg says Mexico “is a little bit more expensive but you are paying for quality.” He suggests that “investor confidence is up because the country is less reliant on energy.”

In Mexico, Strauss likes infrastructural plays like Grupo Aeroportuario del Sureste, S.A.B. de C.V. which holds concessions to operate, maintain, and develop airports. He believes this is a good growth opportunity.

Tan believes energy reforms in Mexico is a long process which will take several years but ‘will be great for job creation” and “will result in infrastructure spending.” She is currently underweight in the country but expects to add to her position. She holds Fibra Uno Administracion SA de CV which invests in commercial and industrial real estate properties and will benefit from continued expansion.

In Brazil, Latin America’s largest economy, managers are less optimistic although they see opportunity in selective stocks.

Strauss “is bearish on Brazil not only because of low oil prices but because it is a big exporter.” But he is “more concerned” about its “leveraged economy.” He says the country is “going into period of fiscal austerity” and is heading into a recession led by consumers.” The “domestic drivers of growth are softening and there is “no turnaround on big infrastructure projects.”
Taylor contends that the appointment of a pro-business finance minister in Brazil will address inflation and implement “more credible fiscal/monetary policies which will however take time to implement.”

In Brazil, Strauss is invested in Embraer S.A., an aerospace conglomerate which he says is “competitive globally when the home currency weakens” – as it has in Brazil.

As a secular play, Tan owns Kroton Educacional SA, the largest private educational company in Brazil and Latin America which will benefit from increased spending in education.

Another country in Latin America that managers are keeping their eyes on is Peru which continues to grow in spite of weak commodity prices, especially copper. Strauss likes infrastructure projects in Peru. He is invested in Credicorp Ltd., the country’s largest financial services holding company which will benefit from infrastructure financing.

In Eastern Europe, Turkey is the favourite among managers. “Its strong economic direction has brought stability to growth,” says Tan. Although reforms are weak “it is a big beneficiary of lower oil prices, which will benefit its large current account deficit,” says Strauss. The country is also benefiting from lower inflation and interest rates. However, Greenberg cautions that security risks “could be a drag” on investing in the country. In Turkey, Strauss likes Garanti Bank, the second largest private bank in Turkey, which has strong growth fundamentals.

Although politically risky, managers are not ignoring Russia. Taylor believes its “extremely ‘high risk/return’ profile is skewed in a positive fashion and that equities markets have discounted the worst-case scenario.” He is using hedging strategies to invest in the long-term potential of Russian equities but cautions that this strategy is “not for the faint of heart”.

Tan also likes selected companies in Russia such as Magnit PJSC, which is the country’s largest retailer, and Yandex NV, which operates the largest search engine in Russia. She is underweighted in the country but says “it has strong businesses” that make for attractive individual stock investments.

In Eastern Europe, Tan is also invested in Poland. She holds Eurocash SA, a leading wholesale distributor of fast moving consumer goods which is growing on the back of a strong consumer.

(A version of this article first appeared in Investment Executive)

Dwarka Lakhan

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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6 comments

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  1. Mike
    Mike 27 February, 2015, 08:30

    Great article Dwarka. What mutual funds would provide good exposure to the Russian market that have low fees associated with them?

    Reply this comment
  2. Carey Benadiba
    Carey Benadiba 16 March, 2015, 17:09

    I have a very negative view on Latin America. Brazil the largest component is a basket case.

    Reply this comment
  3. Jason Buck
    Jason Buck 16 March, 2015, 17:11

    You have to play these regions at the micro level. You have to be stock specific and forget about the country or region. All fundamentals.

    Reply this comment
  4. Jerry Walker
    Jerry Walker 16 March, 2015, 17:13

    Eastern Europe is weaker than they let on. The Russians can simply turn off the pipeline. They rely too much on Russia.

    Reply this comment
  5. Mable Goodman
    Mable Goodman 16 March, 2015, 17:14

    Playing any emerging market has risks. Geopolitical is the biggest. You can have all the right ingredients, but have a corrupt government.

    Reply this comment

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