Global Markets Overview: Latin America
By Tom Ives, Analyst at York IFS Global Market Telegraph
Latin American markets set to recover from recent slump as investors turn to undervalued emerging markets; the emergence of the Brazilian variant undermines the rise in business activity and employment data.
Latin American shares tracked overnight declines in Wall Street on Wednesday, as a stronger dollar and a resurgence in coronavirus cases dampened investor sentiment in the region. The index is currently trading at its lowest level since November at US$2335.83 [i] after regional stocks recorded their largest one-day percentage drop since October 28th 2020. This latest fall has exacerbated the struggles that the region has recently faced, with the MSCI Latin America EM index now extending its losing streak to a third consecutive week.
However, despite the poor performance in recent weeks, Latin American equities look set to become the latest beneficiaries of the rebound which has been enjoyed by major financial markets since the crash in March. Given that the pandemic has devastated economies throughout the world, the upturn in fortunes for global stock markets is heavily divided amongst investors, with major indices continuing to reach record highs into 2021. The combination of rapid rises in stock prices well beyond their valuations; the sudden increase of new participants entering the markets and low interest rates have all played a role in supporting the widespread fears of a market bubble. Some argue that the current market conditions are reminiscent of the highs that preceded the dot.com bubble crash that occurred in the late 1990s/2000s. The term ‘irrational exuberance’, founded by former Fed Chairman Alan Greenspan, can be used to explain the current dynamics of the stock market. The term refers to the prevalence of speculative buying. This is arguably the by-product of the extensive stimulus measures employed by the Fed and has subsequently resulted in stock valuations massively exceeding their earnings.
Whilst the consensus is unclear whether there will be a market crash in the foreseeable future, some investors have looked beyond stretched valuations seen in other markets and have subsequently turned to Latin American assets instead. Unlike most other major markets, regional equities remain massively undervalued compared to their counterparts. The forward P/E ratio has been calculated at 16, much lower than the S&P 500 at 22[ii]. The shift in preferences has resulted in the region profiting from the record level of capital inflows from the past months. This number looks likely to increase further in the foreseeable future, especially if the Fed maintains its dovish stance over the next months. The Ibovespa index led the losses as lingering concerns surrounding coronavirus public finances outweighed positive statements from economy minister Paulo Guedes. During Tuesday’s press release, despite the IMF forecasting a recession, Guedes stated the economy would in fact grow by at least 3.5% this year [iii]. However, his latest announcement has been met with mixed reaction.
Positive employment and high lending data in Brazil suggest that Guedes might be right. Business confidence seems undeterred by the latest setbacks as a sudden uptake in IPO activity means that it has reached its highest level in months. This marks a significant change in the market behaviour seen in December, where IPO activity slowed down to a standstill as firms anxiously waited for investors to regain confidence in the stock market. Brazilian asset management Vinci Partners became the latest firm to file an IPO on the Nasdaq. The firm is expected to raise over $250 million from the IPO, which is expected to finance further acquisitions in Brazil. Experts argue the sudden increase in activity can be explained by the effects of low interest rates on long-term Brazilian bonds. The Selic interest rate has been kept at its historic low of 2%. These low rates of return on long-term bonds have facilitated the switch to equities from local investors. According to Anbima, net new money inflows to the industry totalled 156.4 billion Reais, perhaps demonstrating the market is starting to gain confidence [iv].
However, this sudden emergence of the Brazilian variant has weighed heavily on consumer confidence, as evidenced by a local survey. The Getulio Vargas Foundation's (FGV) index, which measures the level of confidence by consumers on the economy, suffered its fourth consecutive decline. The virus understandably played its role in undermining the recovery of the region in the latter stages of 2020, with the variant seemingly unresponsive to the vaccine. The variant has 3 key mutations in the spike receptor domain, which has worried scientists worldwide as this is the area the vaccine typically targets. It is believed that over ¾ ICU beds in every state in Brazil are already occupied with patients that have been critically affected by the virus [v]. President Bolsonaro has come under further pressure to increase restrictions, with the variant believed to have a much larger mortality rate as well as a higher prevalence in the younger working population.
In addition, the removal of the ‘forward guidance’ employed by the Central Bank has added to concerns surrounding the state of public finances. Previously, the government announced changes to policy decisions well in advance in an attempt to reduce uncertainty amongst consumers and firms. This perhaps is a tactic to divert criticism away from the government, who have come under scrutiny for their over-reliance of fiscal and monetary policy measures over the past year. Although these measures were essential in addressing deflationary pressures in the economy brought on by the pandemic; this has come at the expense of Brazil’s public finances. Debt levels have begun to spiral out of control as emerging markets have borrowed at an alarming pace in 2021. Once renowned for its conservative fiscal spending cap, debt levels in Brazil are now spiralling out of control and further downgrades to credit ratings is expected by the IMF.
This article was first published in University of York Investment and Finance Society's Global Market Telegraph (GMT) Edition 14.1 in early February 2021.
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[i] MSCI EM Latin America Index (MILA00000PUS) - Investing.com UK [ii]https://www.msn.com/en-us/money/markets/ubs-wealth-says-its-time-to-bet-big-on-emerging-markets-shares/ar-BB1d8jOf [iii] https://news.yahoo.com/brazil-reports-job-growth-2020-155907344.html [iv] https://www.bloomberg.com/news/articles/2021-01-27/jpmorgan-s-new-brazil-chief-invites-alumni-to-chat-with-dimon [v] Second Brazil wave strains hospitals in Sao Paulo's interior Sao Paulo Hospitals Brazil hospital wife | The Independent