Gone is the dynamic growth that propelled Latam as one of the top performing asset classes between 2010 and 2012. Just as western economies were attempting to regain their footing, following the 2008 financial devastation, South American economies were on a roll, handsomely benefitting from strong Asian – particularly Chinese – demand for commodities and industrial raw materials. Economic growth was further fuelled by record foreign inflows, in the form of both direct investment and hot capital, driven particularly by carry trade strategies amidst a ZIRP* environment.
Alas, Latam growth was excessively leveraged to the commodity “supercycle”, neglecting diversification into productive areas and policies geared towards the emergence of a middle class. Also, the ensuing credit expansion forced central banks to shift into restrictive mode as consumer prices began to overshoot inflation targets. South American economies such as Brazil, Chile and Peru, traditionally the region’s magnets for foreign capital, thus now find themselves in the midst of a dramatic slowdown, bordering on recession. Worst off of course, is the white elephant: Brazil. Dilma Rousseff’s recent re-election despite her poor economic record – the country is undergoing severe stagflation with GDP down 1% and inflation at 6.75% – makes for low expectations.
Recessions never play out well for social and political stability. South America is known for deceitful political promises of “new beginnings” and frustrated voters taking to the streets to express their deception, loud and clear. Foreign investors will be unwilling to see their capital caught in situations where, when push comes to shove, politicians would rather side with public opinion. As such, it is no surprise that capital flows to emerging markets are already shunning South America in favour of Asia – exacerbating current account deterioration, currency depreciation and sovereign spread expansion across the Latam region.
Remain underweight Latam vs. Asia… but not all is bad
While it is premature to call for a “Sambarazo“ (in reference to Mexico’s 1994 “Tequilazo” which reverberated throughout the continent), we are keeping a careful watch on Brazil et al – as well as our overall preference for Asia within the emerging space.
Colombia and Mexico are notable exceptions to our cautious Latam stance, faring much better than their “camaradas”. The former is, however, starting to show signs of a sizzling real estate market and overheating credit growth. As has been the case in neighbouring countries, central bank obsession with inflation targets may “unintentionally” pop a Colombian asset bubble. In Mexico, the story is one of structural reforms: to reduce dependency on oil revenues, taxes have been raised, in turn pressuring wage growth. Along with subsiding inflation, this means that the central bank can afford to remain easy. Robust US manufacturing is also helping, as a large part of Mexico’s exports go north.
Finally, as regards Brazil, much of the bad news does now look priced in. Opportunistic investors may thus find some selective high return / high risk investments there, particularly in the fixed income space.
Samy Chaar is an investment strategist at Lombard Odier