Latin American fund managers finished 2004 as the reigning champs of Wall Street for the second straight year. Unfortunately, 2005 is shaping up to be a tough year to defend the title.
Like most emerging markets, Latin American stocks soared the last two years on the strength of rising commodity prices in the face of voracious Chinese demand. In 2003 and 2004, Latin American funds gained 62% and 38%, respectively -- much of it coming from energy and mining stocks -- thereby outperforming all other fund categories.
Despite this strong performance, most managers of Latin American funds are tempering investor expectations this year, as they expect commodity prices to level off. Gonzalo Pangaro, portfolio manager of the
T. Rowe Price Latin America fund, says many of the energy and mining stocks that ran up along with oil and materials prices last year are in danger of giving back those gains if prices fall.
Nevertheless, Pangaro still sees healthy gains ahead for Latin American stocks as the Brazilian and Mexican economies continue to expand and the political situations in the two countries remain stable.
chatted with Gonzalo Pangaro to get his 2005 views on Latin American stocks and the politics that help move them.
What are your projections for Latin American stocks in 2005, coming off two very strong years?
We are moderately optimistic about Latin America for this year. We do not expect to see the returns we've seen in 2003 and 2004. But in general we still think that economies are growing and valuations look reasonable. So we expect returns in the order of 15%.
That's still very good! From which countries do you expect to see the best returns?
We are very bottom-up in our research. As you know, Latin America is a very narrow universe of stocks. Our largest positions are in Mexico and Brazil, and that's where we see the best opportunities. The other major market is Chile, but we think most companies are overpriced there, so we have underweighted our position there.
What are some of your favorite stocks?
In Brazil we like
, which is our largest position in the fund. After several years of mild production growth, Petrobras has put some new platforms in place and we expect their oil production to grow substantially over the next few years. The valuation is also compelling here.
In Mexico, we are heavily weighted in
, which is the mobile phone operator there. Mobile phone penetration is still extremely low in Latin America and they are well positioned in most Latin American countries. We expect them to benefit from strong growth in coming years. They have very strong and shareholder friendly management there as well.
Our third-favorite stock is
Wal-Mart de Mexico
, which is 62% owned by
in the U.S. Formal retailing in Mexico is still at a very early stage and we think there is plenty of room for Wal-Mart to keep expanding, as well as grow its operating cash flow at a double-digit rate.
How is China's growth affecting Latin American economies?
China's growth is affecting Latin America indirectly. I think the spike we have seen in commodities prices and steel is the result of China's growth. As a commodities exporter, Latin America has benefited from China's emergence over the past few years.
But what about China's competitive threat as a low-cost producer?
As a low-cost producer, Latin America is not a direct competitor with China. The only exception is in a few industries in the northern part of Mexico, where China's growth has had some negative effects. But they have been recovering.
The rise in commodity prices has obviously benefited Latin American companies and in turn their stocks. What happens if commodity prices move downward in 2005 as many analysts believe they will?
The rise in commodities prices has helped Latin American companies and stocks meaningfully. Materials stocks in Latin America have done extremely well over the last two years. We do not expect this to continue. Most steel companies are running at full capacity and we think that commodity prices have peaked. I think prices will fall and in some cases a few of these stocks will give back some of their strong gains from the past few years.
How will an increase in U.S. interest rates affect Latin American economies and stocks?
It depends on the magnitude and pace of increase. I think the market is discounting an increase in U.S. interest rates. If we continue to see measured 25-basis-point increases, I don't expect to see a major correction in Latin America. If the
increases the pace of tightening, then we may see a meaningful correction in Latin American stock markets.
How is the weak dollar affecting Latin America?
It has not been a huge issue in my opinion. I think commodity prices have been the more important driving issue in Latin America, so I don't have a strong view on the dollar.
Politics plays more of a role in the movement of Latin American stocks than in most other regions. How are the political situations in Brazil and Mexico?
Politics will become an issue mostly in the second half of this year. In 2006 we will have important elections in a number of Latin American countries. And that includes presidential elections in both Mexico and Brazil.
In Brazil, the situation is stable. There used to be many parties but two are consolidating power. They currently have a left wing administration there and Lula has done a great job of maintaining fiscal prudence and promoting reasonable economic policies. The opposition party has also shown that they can be economically responsible, so I am not too concerned about the Brazilian political situation.
In Mexico, Fox has really disappointed on the reforms front. He really has not done much. That election is going to be more complicated. There are three candidates in that election who have been doing well at the polls and have a chance to win, which makes things more uncertain. It's a more complex situation.