U.S. stocks have been spinning their wheels all year, slowly sinking in the process. Meanwhile, Latin American stocks continue to cruise at warp speed, rising more than 30% year to date.
Latin America fund investors surely aren't complaining about the outsized returns, but are their expectations getting a bit warped as well?
Don't take your foot off the Latin fund pedal just yet, says Will Landers, portfolio manager for the $239 million
Merrill Lynch Latin America fund. Landers remains bullish on Latin America even if the U.S. economy starts to sag, oil prices fall and interest rates move higher -- a trio of events that has traditionally sunk South American stocks. According to Morningstar, Landers' fund is up 35% this year, after an impressive 43% increase in 2004.
checked in with Landers to find out why he believes this rally still has room to run, even when U.S. equities seem to be digging themselves into a deeper and deeper hole.
Latin American stocks are up well over 30% year to date, even while domestic stocks are starting to sink. How long can they keep it up?
We believe that we are only in the middle stages of the recovery for Latin American equities. As a region, the market continues to trade well below historic average multiples. It offers the best value-to-growth combination of all the world's regional markets, emerging or developed.
According to the latest fund flows, loads of U.S. investors have been piling into international funds, whether they be Latin American or Asian. Why the big rush out of the U.S. and into foreign markets?
The main reason for this large flow into emerging equities is that these regions offer better growth than is expected in the U.S. at significant discounts from a forward P/E standpoint. Furthermore, if you look at Latin America's three largest markets, Mexico and Chile are investment grade and Brazil has reduced its vulnerability to external shocks significantly -- I don't think this reduced risk premium has been fully discounted in equity markets.
As long as the oil correction is not very sharp -- and I have a tough time envisioning oil prices falling dramatically -- this correction will have little impact on Latin equity markets. At the country level, Mexico is the most dependent on oil -- roughly 40% of the federal budget stems from oil revenues -- but the budget price is $27 per barrel.
What about the mining/commodity rally? How important are gold and copper and silver prices to Latin America?
Copper prices are the main driver of the Chilean economy. Over 7% of Chile's GDP is related to the copper industry, or a little more than 40% of exports. While there are no copper stocks listed in the Santiago exchange, it is the main driver of economic growth.
Gold and silver have less of an impact on the region -- Peru is the one country with significant gold production. Iron ore prices are very important for Brazil as
Companhia Vale Do Rio Doce
is the second-largest stock in the Bovespa -- iron ore prices are negotiated once a year and all contracts follow this price --
and 2006 should see another strong 20% plus price increase.
U.S. interest rates have finally been creeping up on inflation worries. Traditionally, rising rates have not been kind to emerging markets. How will this affect Latin American stocks?
As long as the
finishes the current tightening cycle within 100 basis points of current levels, Latin markets should be fine. Rate differentials would still make the 'carry' trade attractive, and the fact that most Latin Central banks were preemptive in raising rates should allow the markets to deal with higher rates in the U.S. without much disruption.
Latin American funds are primarily composed of Brazilian and Mexican stocks; neither has a great economic history. Are both countries okay if there is a global economic downturn?
Brazil and Mexico are today in much better shape to deal with external shocks -- both countries have free trading currencies, and currency pegs were a major culprit of previous crises. While Brazilian debt-to-GDP still stands close to 50%, less than 4% is U.S. dollar denominated; Mexico has debt-to-GDP at 20%, virtually all in pesos. Both countries can therefore withstand an external shock, and very few internal macro/fiscal issues that concern us at this stage.
Which stocks/sectors do you like the most? The least?
Brazil remains our large overweight at the country level, with a mixture of export, mostly mining, and domestic things like retail and banks. We are underweight wireless and pulp/paper stocks. We have a slight overweight in Mexico, preferring the homebuilding, cement and infrastructure sectors, while being underweight the wireline telcos and the consumer sector. Chile remains an attractive economy but an expensive equity market.