Despite the ongoing turbulence, Latin America ended 2022 among the top-performing equity markets. Returns were driven by supportive valuations, a recovery in earnings and the cyclical component of the Latin America benchmarks.
These factors should remain in place and drive markets in the coming year, particularly as the Chinese economy re-opens. That said, we remain vigilant about developments within Latin America. Policy direction from Brazil’s new government is still unclear and the political environment across the region is fluid. A degree of uncertainty is inherent in Latin America and continues to challenge investor convictions. Nonetheless, valuations suggest long-term investors could be compensated in due course. We could certainly see several stocks re-rate once uncertainty fades.
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.
While Lula was a known political actor, the role and character he would play as president was harder to predict. His initial moves surprised many. During his campaign, he held constructive and pragmatic talks with the private sector. However, populist remarks during his first few days in office soon overshadowed this progress. Proposals included a generous fiscal budget that raised concerns about economic prudence and his respect for the central pillars of the Brazilian macroeconomic framework. These signals went against the path of a much-needed public debt consolidation. They also created unfavourable conditions for the start of a monetary easing cycle in 2023. The consequent negative response was particularly visible in the sharp reactions of the local yield curve since November.
Amidst a highly polarised society, concerns around a disputed outcome have also diminished. Disruptive actions by right-wing groups during protests in Brazilia were condemned by representatives across the political spectrum. Demonstrations were quickly contained. Yet, they served as a reminder that Brazil is a divided country and of the hurdles facing the new president. Even so, the election of a balanced congress was positive. Broad representation normally provides an appropriate backstop to the party in power. However, we’ve yet to see if this dynamic will be enough to enforce pragmatism in the Lula administration. Such an outcome would be positive for investments.
The commodities-rich Brazilian economy is currently in a stronger-than-expected position. It’s also well placed to benefit as the Chinese economy picks up. Meanwhile, Brazil’s central bank hiked rates decisively in 2022 and brought inflation under control. Unemployment is at a seven-year low. Importantly, there’s a healthy pipeline of infrastructure investment which, if preserved, should bear fruit over the coming years.
President Lula is also willing to put Brazil back on the global stage in the climate debate. Already, he’s pledged to reposition the country as a natural resource base. This will entail stricter protections for the rainforest while seeking to place the country as a powerhouse in renewable energy. Additionally, the new government aims to address income inequality, foster education penetration and revamp housing programs. Companies exposed to these sectors could benefit.
Nevertheless, the country is not immune to the pressures facing the global economy and Brazil is likely to slow in 2023. The task of igniting domestic growth is not easy, particularly if interest rates are kept higher for longer. All the same, we believe the conditions remain in place for a cyclical recovery should pragmatism prevail.
Mexico
Mexico changed its government in 2020, with Andres Manuel Lopez Obrador winning the presidency. At the time, many expected him to adopt a hard-left approach. Markets were spooked, while investment and valuations fell. Fast-forward three years and the situation has improved. Investors were compensated by retaining exposure to what proved to be a resilient economy, with pockets of growth within the consumer segment, as well as companies and regions with proximity to the US.
The country’s currency and fiscal position remain strong. An estimated 6% of gross domestic product is made up of ‘remittances’ – money Mexicans make abroad (typically in the US) and send home to their families. These remittances have grown with the jump in US wages. Tourism, Mexico’s major industry, has also bounced back. Visitor numbers are up 25% on pre-Covid levels, boosting airport traffic. Against this backdrop, inflation has been stickier than the Bank of Mexico expected. It has been hiking interest rates, keeping pace with the US Federal Reserve (Fed).
The new North American Free Trade Agreement has strengthened ties between Mexico, the US and Canada. But the big story for Mexico is the post-Covid ‘near-shoring’ trend. Companies have sought to resolve supply-chain issues and reduce the cost of shipping by manufacturing closer to home. Mexico is a big manufacturing hub with attractive wage levels that borders the US. Historically, the country was known for its car industry but a broader range of companies in the technology and healthcare sectors are showing intentions to move or expand facilities. As a result, industrial warehouse rents in specific areas have risen by up to 20% and vacancy rates are low.
The northern region of Mexico remains dynamic. This is often overlooked by investors who focus on the lacklustre performance of the wider economy. We think this dynamism, coupled with the high interest-rate environment, should support upward earnings revision for a number of banks, particularly those exposed to the north.
Chile, Peru and Colombia
There’s been a significant swing towards leftist parties in Chile, Peru and Colombia. The common link between the three nations is public discontent and deep social inequality. Election campaigns were extreme. The reality, however, has been less dramatic than feared. Ultimately, realism has been enforced by existing institutional backstops and the prevailing macroeconomic norms.
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. Politicians have appointed sensible finance ministers and afforded them a free hand, which is giving markets confidence. Meanwhile, Colombia’s tax reforms have been designed to encourage – or at least not put off – much-needed investment.
Fundamentally, these economies have favourable demographics, opportunities for investment in underpenetrated sectors and vast oil reserves. As for the future, they’re also rich in much sought-after natural resources like rare minerals, lithium and copper – materials that will be vital as the world increasingly focuses on climate change and the energy transition. Trade in these resources will also cement new relationships beyond Latin America’s historical links with China.
What's the outlook for investors?
Many Latin American countries have a history of tackling high inflation. This time, central banks in the region have retained independence and again acted quickly to raise rates, sometimes ahead of the Fed. Meanwhile, despite social divides and rising populism, policymakers and the general population remain broadly supportive of measures that will preserve economic stability. After all, many nations still bear the scars or have witnessed the ramifications of extreme ideologies of the past. Encouragingly, Latin American countries are also strengthening diplomatic ties globally and assuming a more prominent role on the international stage. These factors combined are building a greater resilience at the heart of the region.
While Latin America has been able to decouple from world events, it’s not entirely immune to factors beyond its shores. Its status as a commodity-rich region with indirect links to China can be a double-edged sword. All the same, Latin America is more insulated against a strong US dollar than many other emerging markets. Commodities are priced in dollars, so the region’s exporters benefit from a rising greenback. Corporate earnings, however, remain subject to the cyclical nature of the industry.
But the region is about more than commodities. On the domestic side, we see an attractive pool of companies that are expanding into underpenetrated segments across consumption and financial services. Weak infrastructure, subpar education and healthcare systems, as well as inequality, are ongoing challenges – they’re also huge opportunities for companies that can help address these issues.
Latin American businesses have demonstrated their ability to perform in difficult times. Many have strengthened their competitive positioning despite weak demand and the high cost of capital. True, elevated interest rates have put pressure on companies’ balance sheets. However, we expect many to bounce back as inflation stabilises and the monetary easing cycle materialises.
As for investors, Latin America outperformed wider emerging market equities over 2022. This performance, however, has varied greatly across sectors. It was still weak on a historical basis. Despite this, we believe investors will be rewarded for looking beyond headline benchmarks and following stock-specific insights. Our process focuses on bottom-up, company fundamentals. Through this lens, we see a wealth of quality Latin American companies with solid balance sheets and sound ESG credentials that are run by world-class management teams. We believe that these companies will not only survive the current challenging environment – but thrive over the medium- to long-term.