Discovering emerging markets - Part II

Latin America

Although not comparable in terms of gross domestic product to the Asian emerging markets, the countries of Latin and Central America also have a role to play in the global economic landscape that should not be underestimated. Brazil and Mexico are among the world's top 20 economies in terms of GDP, and in 2023, despite the burdens of Chile (-0.5%) and Argentina (-2.5%), the South American region grew in real terms by 1.6%, more than Europe (+1%) and the advanced economies (+1.5%). 

However, what makes investing in this area less attractive is what appears to be perennial and inherent political instability. There are many countries between Central and South America that experience particularly tense domestic political situations. In recent months, the attempted coup by drug traffickers in Ecuador, the announcement of the resignation of the prime minister of Haiti in the face of a country overwhelmed by gang violence, the disaster of the Venezuelan economy, where almost 52% of the population lives in extreme poverty, and Argentina's hyperinflation caused by dastardly government policies have all made headlines. There are, however, some countries that may conceal interesting opportunities. 

Growing by 3% in 2023, Brazil is the leading economy in the region. 2023 was a year of economic recovery for Brazil, coinciding with a slowdown in inflation that allowed the central bank to expand monetary policy with four consecutive rate cuts, from 13.75% to 11.75%.

Moreover, according to an OECD report, growth is expected to remain strong over the next three years thanks to an increase in exports of agricultural products and private consumption, driven by the creation of new jobs. Against this economic backdrop is the general increase in earnings by major Brazilian companies listed on the São Paulo Stock Exchange, in an overall picture that nevertheless maintains very discounted valuations with a p/e of almost 30% below the historical average. There are also interesting opportunities in the bond market, which offers excellent yields. Market rates are between 10 and 11% for short-term securities and for those with maturities between 5 and 10 years, while for medium-term securities the yield drops to around 9%. In addition, the exchange rate risk appears relatively low compared to the past, considering that the Brazilian Real has fluctuated less than 5% over the past year.

A very similar argument can be applied to Mexico, whose economy grew by 3.2% in 2023. Here too, the valuations of the main stock index, the Mexbol, appear to be discounted (p/e of 13% below the historical average). As for the bond market, the yield curve of Mexican government bonds is also inverted, albeit in the 3-month-10-year range, with yields close to 11.5% for short maturities and around 9.5% for longer maturities. As with Brazil, the currency appears more solid for Mexico than in the past, but there remains a risk component to consider.
In order to better interpret this slew of numbers, let us try to broaden our gaze towards a more general view of Mexico's economic outlook.
Mexico seems to be one of the countries best positioned to benefit economically from geopolitical changes. The reason is its proximity to the United States and the possibility of what competitive strategy experts would call 'nearshoring' (defined as the relocation of a company's activities to a country close to the parent company). This shift, which is happening mainly due to trade tensions with China and general geopolitical instability, has made Mexico the largest trading partner of the US, leading to a significant strengthening of the Mexican peso.
Mexico seems to be one of the countries best positioned to benefit economically from geopolitical changes. The reason is its proximity to the United States and the possibility of what competitive strategy experts would call 'nearshoring' (defined as the relocation of a company's activities to a country close to the parent company). This shift, which is happening mainly due to trade tensions with China and general geopolitical instability, has made Mexico the largest trading partner of the US, leading to a significant strengthening of the Mexican peso.
What worries investors most, however, is once again politics.
The old-school leftist government of Lopez Obrador has not formulated a comprehensive strategy to attract or direct investment, while the security issue remains unresolved, with criminal groups increasing their extortion and violence and their control over local governments.Meanwhile, the biggest elections in the country's history are just around the corner, in which citizens will be called upon to choose a new president, both houses of Congress, eight governors and thousands of local representatives, and tensions are mounting. According to data from the NGO Electoral Laboratory, 19 political murders have been recorded in recent months, perpetrated by criminal groups, fragmented into smaller and smaller organisations, which seek to eliminate candidates they cannot control.

Speaking of Latin America, we cannot fail to say a few words about Javier Milei's Argentina. The fundamental question is: will the ultra-liberalist's 'desperate' recipe succeed in reviving a country that has experienced five defaults since the 1980s?
At the moment, the Argentine economy is in a disastrous condition. OECD estimates for inflation in 2024 exceed 250%, while the Argentine president has raised the currency's valuation from 365 to 800 pesos per dollar in order to reduce the gap between official and unofficial dollar prices (which now stands at around 20%). The weak currency, the recessionary economy (GDP fell by 2.5% in 2023) and the astronomical increase in prices led to a further increase in poverty, which now exceeds 50% of the population.

Confusion reigns supreme in a disastrous economic environment where there are no ordinary solutions and every decision, rather, appears desperate and extraordinary. Recently, for example, although inflation is still galloping, the relatively encouraging inflation figure for February (13.2% against the expected 15%) prompted the central bank to cut rates from 100% to 80%, probably in an attempt to reduce Banco Central's liabilities in real terms.

The goal remains to reach zero deficit as early as 2024 by raising taxes and decreasing spending. However, the ambitious programme has started to encounter its first obstacles, with the Argentine Senate blocking the broad emergency decree to deregulate the economy presented by the president.
So, considering that the 'La Libertad Avanza' coalition led by Milei only controls 7 of the 70 seats in the Senate (against the 45% controlled by the Peronist opposition), his enterprise takes on increasingly titanic contours.

Let's take a closer look at Latin America, albeit limiting ourselves to Brazil as a potential area for action in the stock market.