By Heinrich Lessau, MD Research at Credicorp Capital Chile
Global flows on turning sentiments and events affecting rates and liquidity outlooks, such as Brexit and the US presidential election, have and will most likely continue to be the dominant force in the evolution of emerging equity markets. The latest mayor event, the election of Donald Trump as the next president of the United States of America has risen concerns on global trade but have also increased expectations for infrastructure-centered fiscal spending, with observed impacts on US interest rates, commodity prices and the subsequent global risk off that we have seen. Latin America is significantly better prepared this time around than in previous liquidity events as most of its economies allow their currencies to float freely (and to absorb a significant amount of the impact). While higher degrees of economic integration have increased the cyclicality of Latam economies, it is also true that private and public balance sheets are also more robust. As a predominantly commodities exporting region, the recent negative adjustment in terms of trade have resulted in significant external deficits, but most countries have managed to adjust to this reality in an orderly fashion.
Latin American markets have had differentiated trends in the midst of this global context with local fundamentals playing a significant role, more so than in previous cycles. For once, Mexico has been hardest hit due to policy uncertainties in the US that may lead to a revision of the trade ties between the two countries. On the other extreme, the Brazilian market continues to be rewarded as the new government delivers reforms, particularly on the fiscal front. As a result, for the first time in many quarters, Mexico trades discounted with respect to Brazil but the opportunity seems far from obvious. Argentina has been a strong performer ever since Macri became a competitive candidate and continued to reward investors as its new government launched a bold program of reforms to normalize its economy, allowing markets to operate more freely and reducing the role of government discretion in its economy. After substantial gains, market enthusiasm has lost some steam as private investment, perhaps the most relevant figure to watch in Argentina, continues to be timid. Next year’s Congress elections will be a key test for the Macri administration and its program.
We at Credicorp Capital believe the Andean markets (Chile, Colombia, Peru) are well positioned to outperform the region in 2017. Peru managed to achieve positive outcomes in several binary events over the last year, including a weaker than expected El Niño phenomenon, staying as part of the MSCI emerging index and mostly, electing a pro market government that has lifted sentiment among consumers and investors. A recovery in domestic demand has so far failed to meet expectations, in our view primarily because of the lag effects of soaring unemployment during the latter half of the previous administration. We are confident, however, that the government is in the process of implementing deep and transformative reform to Proinversión, the government agency in charge of dealing with the country’s largest infrastructure projects. Moving forward some key projects such as the second subway line of the city of Lima or the construction of a large pipeline to bring gas to the southern regions of the country, will be decisive for the private sector to regain confidence and to deploy much needed capital. Consumer sectors, construction and infrastructure are generally expected to outperform over the next year.
Peru also shares the benefits of the recent pickup in copper prices with its southern neighbor Chile, as both countries are the largest worldwide producers of this base metal. After three difficult years of political polarization, regulatory uncertainties and sluggish economic growth, Chile faces its upcoming presidential elections with growing optimism. After antagonizing investors and significant segments of the population with deep education, tax and labor reforms, and the threat of constitutional, health care and pension reforms, failure to deliver economic growth (among other factors) has eroded the popularity of its government. This has been read by the markets as a substantial reduction in the perception of regulatory risks. The right wing opposition managed to beat the ruling coalition in a recent nationwide county election, which increases the chances of the country electing a more moderate, market friendlier government next year. Over the next twelve months, sentiment will move along with presidential polls but there is a growing perception that things are starting to move in the right direction. Consumer exposed sectors including Chile’s large retail and banking industries, as well as beaten regulated industries such as health care and pension managers, are well positioned to outperform.
Finally, Colombia continues to adjust its economy to lower Oil prices –once its largest export— which accounted for up to 30% of its fiscal revenues in 2012-13. Collapsed Oil prices generated huge fiscal and trade deficits in the subsequent years and have forced the Santos administration to launch a comprehensive tax reform that should be passed before year-end 2016 to become effective in 2017. Failure to do so –not our expected scenario— could trigger downgrades by risk rating agencies. We expect the reform to rely heavily on increased VAT to meet collection targets, while a drop in corporate taxation will allow over-taxed Colombian corporations to become more competitive. Longer term, a diversification of tax revenues plus the transformative impact that should come from the end of the military conflict with the guerrillas will drive upside in this market.