2018 is set to be an eventful year for Latin America. The region is facing a full calendar of political events with a Mexican general election planned for July and Brazil’s presidential election taking place in October.
Brazil, the biggest economy in the region, exhibited GDP growth in 2017 following two consecutive years of recession. Further positive economic momentum, including low interest rates and inflation, is expected to continue over the next 12 months.
The positive impact of policy change is also expected to continue in Argentina, which posted growth in 2017 following GDP contraction in 2016. Argentina benefits as well from a high appetite from investors, providing capital to pursue growth and investments.
Mexico’s economy, meanwhile, continues to grow at an average rate and its consumer sector continues to outstrip overall GDP growth.
The Andean region is still growing at sub-optimal rates, as the adjustment to lower prices of its main commodities continues. With respect to Chile, a recent election victory by Sebastián Pinera is likely to boost investment confidence and growth expectations.
In 2018, Brazil is set to continue the economic recovery evidenced in 2017 following two years of recession. The political agenda remains very busy. President Michel Temer’s government managed to implement several bold reforms, such as the spending cap bill and labour reform, aimed at stabilising Brazil’s fiscal path. Furthermore, since former-president Dilma Rousseff’s impeachment, state-owned companies are improving corporate governance and capital allocation practices.
The election set to take place in October is likely to create short-term volatility. The final list of candidates is still unclear and Brazil’s political class is plagued with corruption investigations, making it too early to point out a clear leading candidate.
Considering the high level of political uncertainty on the one hand, and the positive economic scenario on the other, investors should focus on companies’ fundamentals and operating drivers. The outlook is positive considering the combination of GDP growth, low rates and low inflation, and Brazilian companies can benefit from this and other factors such as lower funding costs and volume growth resumption. Accordingly, this economic scenario is supportive for firms in various sectors, including consumer, industrial, toll roads and utilities.
Argentina continues to benefit from the positive momentum engendered by Mauricio Macri and his Cambiemos party’s election victory in December 2015. In 2001 the country experienced one of the worst economic crises in its history as output fell, inflation picked up and the government defaulted on its debt, exiling it from global debt markets. In 2009 the market was downgraded from emerging markets to frontier markets status due to strict capital controls imposed by the government. As a result, both international debt and equity markets were closed to Argentina and its corporate sector for many years.
The turnaround began when Macri was elected. He and his party have forged a new path, seeking to normalise the economy, reduce the very high inflation and fiscal deficit and open the country up to international investors. The government has focused on removing capital controls and letting the peso rate float in the market; lifting utility tariffs to reduce electricity subsidies; and reaching agreement with past creditors to reopen access to international capital markets.
These significant adjustments led to GDP contracting in 2016. In the following year the economy returned to growth and, politically, a positive mid-term election result meant Macri and his party strengthened their position in Congress. Furthermore, Argentina’s capital markets reopened. Both equity and debt investors are exhibiting a strong appetite for offerings from both government and corporate sectors.
Even though the challenges of tackling inflation and the fiscal deficit remain significant, the outlook for 2018 is expected to remain positive. The success Argentina exhibited in attracting capital in 2016 and 2017 enables both the government and the corporate sector to invest in the local economy. Equities are expected to sustain their momentum in 2018 due to the high likelihood of Argentina being included in the MSCI Emerging Markets Index by 2019, having been excluded since 2009. Also, there have recently been several successful IPOs and follow-ons, including within financials and the cement space, which is increasing the Argentinian investable universe. Given that success is dependent on Macri’s reform agenda, it is important to monitor both his popularity and the government’s mid-term targets.
The main headwind weighing on Mexico’s currency and equities performance since Donald Trump’s election win in November 2016 is the ongoing NAFTA negotiations with the US and Canada. In addition, Mexico’s next presidential election is in July, and even though it is too soon to call the winner there is a high risk that left-wing candidate Lopez Obrador will win. Markets are likely to react to this negatively. However, it is important to note that Mexico has exhibited central bank independence and fiscal prudence for many years.
Mexico’s currency fluctuated significantly in the run-up to, and aftermath of, Trump’s election. Considering the country’s corporate sector is characterised by companies with dominant market positions and strong balance sheets, this volatility offers opportunities for long-term investors to invest in strong firms at reasonable valuations.
Moreover, despite some alarmist rhetoric it is unlikely that the strong trading relationship between the US and Mexico will significantly weaken. Since the introduction of NAFTA in 1994, the level of cross-border integration has increased significantly. Take, for example, the auto industry: Mexico has doubled its share of US auto imports over the past 20 years. More generally, many of these imports are for intermediate components that are used in the manufacture of goods made in America. Many US companies have longstanding relationships with Mexican manufacturers, and in recent years sectors like aviation and automotives have made significant investments in increasing their Mexico manufacturing capacity.
The domestic economy is growing at a reasonable rate and Mexico’s fiscal position is strong. However, considering that 33% of GDP is derived from exports, 81% of which are destined for the US, clarity regarding NAFTA is needed to reduce this high level of currency volatility and properly assess investments in companies directly exposed to trade with the US. Therefore, in terms of investment opportunities, our focus remains on companies with exposure to the domestic economy, such as supermarkets, convenience stores and restaurants, which are all benefitting from the resilient Mexican consumer. In addition, we are constructive on banks due to healthy asset quality trends and low financial penetration.
Weathering political uncertainty
Latin America’s main markets provide a dual narrative: on the one hand, political events may create short-term uncertainty; on the other, economic drivers seem healthy and growth trends are expected to continue. In this environment, it will be important to look not just at sector trends, but at the companies that are well run and exposed to healthy domestic trends. These companies are best positioned to weather the short-term political uncertainty that 2018 will bring. Active management, specifically stock selection, will play a crucial role in successfully navigating this dual narrative.
Ilan Furman - Portfolio Manager, Global Emerging Markets Equities - Columbia Threadneedle Investments