By Jorge Amato
Head - Latin America Investment Strategy
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We have high conviction that Latam equities will rebound. However, that will take some time, and we advise investors to position for the potential opportunity.
Latam equity markets have always been a cyclical play, dominated by a confluence of domestic idiosyncratic variables, international financial conditions and commodity markets. Global shocks have historically had an outsized negative impact on the region relative to other markets.
Averaging the returns from the peaks and troughs of four of the largest market moves of the last 20 years reveals that while Latam equities have been the “Ugly Duckling” of the crisis periods, averaging 44% return draw-downs, they also have the potential to transform into the “Beautiful Swan” when markets recovered, averaging 78% upside.
We believe this underperformance can be explained by the region’s history and the significant cyclical tilt in its equity indices relative to other regions and to more diversified benchmarks. As our base case scenario for a global recovery materializes into 2021-2022, we expect the global cyclical sectors to recover and outperform. We expect Latam to participate in that move.
Brazil is our preferred market to play the recovery. Brazil is the largest Latam economy, ranking as the 9th largest global economy in the world with a GDP close to $1.8 trillion. With a population of over 212 million, it has the 6th largest population and one of the largest domestic consumption markets in the world. Finally, it is home to a number of world class companies that add up to an equity market capitalization estimated at approximately $1trn. These characteristics combined result in a large dynamic economy and an investable equity market.
While we fully recognize the inherent risks of Latam equity markets, we believe current levels are pricing in the widely expected economic and earnings contraction, yet very little of the recovery. The current global economic recovery is unlike any we have seen in recent decades. The path of recovery depends heavily on the development of a vaccine.
Therefore, a full global economic recovery is likely to take longer than in previous recessions, generating uncertainty and anxiety in investors. Latam markets are usually never the first to bounce.
Much like our other calls on global cyclicals, small and medium capitalization and value, Latam equities will only consolidate their recovery once investors have confirmation that all is clear on the pandemic front. We have a high conviction that Latam equities will rebound though it will take some time, and we advise investors to position for the potential opportunity.
Read Latin America Investment Strategy
Current levels provide enough of a discount to suggest that global investors should continue to diversify and, rightly sized and with an opportunistic and tactical view, own Brazilian equities in their portfolios. The Global Investment Committee has an overweight allocation to Brazilian equities since May.