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The two largest Latin American economies, Mexico and Brazil, both elected populist Presidents in 2018 – and the new guard look set to impact stock markets this year. Right-wing conservative Jair Bolsonaro came to power in Brazil this week and the left-wing Andrés Manuel López Obrador, known as AMLO, was appointed last month in Mexico, but both are already causing waves.
As for most stock markets, 2018 was tough for Latin America, with MSCI Mexico underperforming the wider emerging market complex in US dollar terms losing 17.5% compared to the sector's losses of 16.6%. In contrast, Brazil was down just 4%.
The changing political situation added volatility, and Mexico also faced the uncertainty surrounding negotiations with the US and Canada over the North American Free Trade Association (NAFTA).
But with both new Presidents now having taken up their positions and the NAFTA replacement, the US-Mexico-Canada Agreement (USMCA), agreed there should be fewer headwinds for the respective stock markets.
“Markets have been buoyed by a reduction in political uncertainty and strengthened hopes that key areas of reform will now be addressed,” say Will Lam and Ian Hargreaves, co-heads of Asian and emerging market equities at Invesco.
Still, investor attention will now turn to policies, where both Bolsonaro and AMLO prove divisive. The former, say analysts at Aviva, must navigate a fragmented Congress to deliver necessary fiscal reforms; the latter must walk a fine line between delivering on campaign promises and adhering to fiscal prudence.
Bullish on Brazil
The appointment of Chicago-trained economist as Brazil's Finance Minister Paulo Guedes has been largely welcomed by markets. Pensions is one key area of reform he has already identified, with pension costs currently represent 55% of primary government spending. Tax cuts and simplifying the tax system is another area of focus.
Lam and Hargreaves both note these “would help reduce a large fiscal gap and go some way to restoring investor confidence and promoting consumption growth and investment spending”.
After a recession between 2014 and 2016, the pace of Brazil’s economic recovery since has been “sluggish”, the managers say. However, there’s cause for optimism here. Analysts at Bank of America Merrill Lynch expect the country’s post-election rally, which saw the Bovespa index jump 11% in the third quarter, to continue.
Growth for 2019 is predicted to come in at 3% by Aviva, while inflation is set to remain subdued as it moves modestly above 4% towards the end of the year. This will support an accommodative stance from the central bank, they add.
“The combination of easy financial conditions and an anticipated boost to confidence driven by a business-friendly administration will support consumption and investment.”
Sheridan Admans, investment manager at The Share Centre, says he continues to hold a positive long-term regional bias towards Brazilian equities. “With consumer sentiment in the region topping expectations, ongoing economic recovery and attractive valuations, the region continues to remain appealing,” he explains.
As ever with a new – and untested – political regime, risks are prevalent. Chinese investment and the re-negotiation of Mercosur, the South American trade agreement, are among those highlighted by Nicholas Hardingham, senior vice president of Franklin Templeton’s fixed income group.
But the biggest risk is the potential failure to pass fiscal reforms, particularly pension-related ones. The pension costs will continue to pressure debt ratios if left unchecked, say Aviva.
“The highly disjointed political environment makes Bolsonaro’s task more difficult, but an improved growth outlook and key political appointments should help generate enough political will to push through much needed reform,” they add.
Cautious on Mexico
New Mexican President AMLO was also initially considered a market-friendly candidate but concerns around that thesis have surfaced since his initial speech, says Hardingham.
Scrapping plans, via a referendum, to build a new airport in the capital, Mexico City, will not have gone down well with the business and investment communities. Meanwhile, Aviva harbours concerns around his “ambitious” spending plans.
These will “pressure inflation expectations and the currency and limit the central bank’s ability to ease policy, despite the current restrictive policy stance and with expectations for core inflation to fall towards 3%”, they say.
Bank of America Merrill Lynch is bearish on the fixed income outlook for Mexico, outlining concerns that credit rating downgrades are very possible.
Aviva concludes: “With the consumer likely to be the sole driver of growth and domestic fiscal risks and high exposure to the external environment, 2019 is likely to be another challenging year for the Mexican economy.”
The Best and Worst of the Rest
Whatever problems Brazil and Mexico had in 2018 and challenges they face in 2019, they pale in comparison to those of Argentina. An “economic meltdown” led to a currency crisis and bail-out package from the International Monetary Fund last year, which in turn led the index losing half of its value in US dollar terms, its worst performance since 2008.
The furore has seen current President Mauricio Macri’s re-election chances plummet, according to Hardingham. However, he counters, a fragmented opposition may fail to grab power.
Uncertainty, therefore, will persist in Argentina. That said, there are pockets of value and Ariel Bezalel, manager of the Morningstar Silver Rated Jupiter Strategic Bond fund, has added to his position in short-term Argentinian bonds.
Elsewhere in Latin America, Aviva predicts GDP growth for Chile, Peru and Colombia in the 3-4% range. These economies will be supported by positive domestic labour markets and stronger investment aided by stable commodities, supportive confidence readings, and potential tax changes.
Consumer price index inflation should steadily move back towards target. Added together, these factors should see all three central banks removing monetary policy accommodation at a gradual pace as the year progresses.
Laith Khalaf, senior analyst at Hargreaves Lansdown, highlights the Morningstar Bronze Rated JPM Emerging Markets fund, managed by Leon Eidelman and Austin Forey for investment potential in 2019.
The fund has around 15% in Latin America, including Argentinian e-commerce player MercadoLibre (MELI). The experienced managers focus on quality companies they think can grow earnings sustainably, says Khalaf.
Morningstar Silver Rated Lazard Emerging Markets, another with around 15% in Latin America, is suggested by Adrian Lowcock, head of personal investing at Willis Owen. The fund holds Banco do Brasil (BBAS3) in its top 10 stocks.
Manager James Donald’s insights are a key advantage for the fund, says Lowcock. “The focus is on firms with improving financial productivity that has been overlooked by the market,” he adds, with particular attention paid to cash flow and its impact on the balance sheet and shareholder value.
For a closed-end option, Khalaf likes the Silver Rated Murray International (MYI), managed by Bruce Stout. The trust’s Latin American exposure includes an equity stake in Chilean chemicals company Sociedad Química y Minera (SQM) and debt holding in Brazilian miner Vale.
Stout has retained a bias towards Latin America and Asia in recent years due to attractive valuations relative to the US, says Khalaf. It may have been painful and the wrong call recently, but he’s happy to keep investing there.