The world is changing, and diverging, says Chris Brinkman, manager of the BlackRock Latin American investment trust. As trading patterns shift, Latin American may be able to take advantage.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
2023 has been characterised by geopolitical conflict across the globe. These conflicts have no easy resolution. As the world continues to divide, those countries that can steer a middle path look set to reap the benefits in terms of trade, investment and economic growth. Latin America should be in a prime position.
Economic and political power is shifting. It appears to be moving from a unipolar world, dominated by the US, to a multipolar world, where countries align with either the US or China, depending on where their economic and military interests lie. This is likely to shape trading patterns and economic partnerships over the next decade.
There is however a third group. These are countries that are not aligned with either side. In our view, those countries are in a far better position to forge trading links, to gather foreign direct investment and to source precious materials necessary for infrastructure building. Many Latin American countries recognise the advantages in steering a neutral path.
Many countries in Latin America are already benefiting from this neutrality. Brazil is currently running one of the strongest trade balances it has had in 30yrs.1 In 2023, Brazil recorded a trade surplus of $99bn, which compares to $63bn in 2022, largely driven by strong export volumes and prices.2
In Mexico, a range of international companies – including companies from the US and China - are setting up new plants as they seek to diversify their supply chains. Companies such as Tesla are harnessing local manufacturing know-how to expand there. This has helped drive economic growth. We believe there is more to come: Mexico now looks increasingly cost-competitive against China, with a lower minimum wage.
Interest rates
These changes should be a long-term tailwind for growth across Latin America, but there are also short-term supports for the region. Here, Latin America’s reputation for economic management is at odds with reality. Its central banks have managed inflationary pressures far more effectively than their Western peers. They were early to raise rates, and are now in a position to bring them down.
The Brazilian central bank, for example, started hiking in early 2021,3 more than a year before the US Federal Reserve.4 Peru and Chile have also cut rates, and we expect further cuts ahead. They are one of the few regions with positive real interest rates (where interest rates are ahead of inflation). This gives central banks significant room for manoeuvre. This should create positive momentum for the economies in the region.
The management of inflation has been a high point for the credibility and competence of economic management in the region. However, there have been concerns in Brazil that President Lula will waive fiscal discipline and enact significant social spending programmes. Here too, reality has proved different to expectations. Lula’s party does not have a majority Congress and has been blocked in a number of his spending initiatives. It is also worth noting that Brazil has recently passed a landmark constitutional amendment focused on simplifying the country’s complex tax system.5 This may remove a significant disincentive for international companies investing in the region.
We are increasingly confident that the fiscal outlook in Brazil will be benign. The recent fiscal framework announced by the Brazilian government was more conservative than expected. Equally, it is worth noting that Brazil’s fiscal deficit is small relative to those of the US and UK. Countries across Latin America have generally proved more conservative than their reputation suggests.
Valuations
A final point in Latin America’s favour is that the stock market remains attractively valued, relative to other emerging markets, and to its developed market peers. The MSCI Latin America index trades on a price to earnings ratio of 8.9x, compared to 11.5x for the MSCI Emerging Markets and 16x for the MSCI World.6 While price to earnings ratios are an imperfect measure of value, they can demonstrate when a market is out of favour. At the moment, we find most value in Brazil, particularly in the consumer discretionary, retail and real estate sectors. These are likely to be the key beneficiaries of falling interest rates.
Latin America has often been underestimated by investors. Yet its central banks have shown strong management through the pandemic, and many of its policymakers are exercising restraint on fiscal spending. It is in a prime spot to take advantage of the shifting political landscape. We are optimistic for the year ahead.
Sources:
1 Trading Economics - Brazil balance of trade – 18/01/24
2 Bloomberg – Brazil’s export boom – 18/01/24
3 Trading Economics – Brazil interest rate – 18/01/24
4 Trading Economics – US federal fund rate – 18/01/24
5 FT - Brazil passes long-awaited tax reform – 15/12/23
6 MSCI – Latin American Index – 29/12/23
Risk Warnings
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Fund-specific risks
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Currency Risk: The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of the investment.
Emerging Markets: Emerging markets are generally more sensitive to economic and political conditions than developed markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
