By Jorge Amato
Head - Latin America Investment Strategy
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Latin America has outperformed other financial markets in Q1
Global financial markets have had a rough first quarter. Performance has been influenced by increased uncertainty over growth expectations. Inflation and protectionism fears have fuelled volatility and created doubts in investors’ minds.
However, Latin American markets’ Q1 performance has been strong, outperforming other financial markets. The Latam MSCI gained 7.24%, local currency bonds (Barclays Unhedged) were up 6.4%, external debt (Barclays USD) lost 1.8% on the back of higher U.S. yields while a basket of currencies (JP Morgan LACI) was up 2.21%
While we hold a positive outlook for the cyclical economic recovery in the region, we acknowledge that the global backdrop has become more challenging. However, we are yet to see convincing evidence that suggests that a sharp deceleration in global growth is imminent.
Regional macro dynamics remain constructive with growth expected to accelerate in 2018, inflation measures reveal a constrained outlook for prices and consumer confidence is rising. Region specific risks seem, for the moment, to be contained to political events.
In Colombia, the presidential race is pointing to a center-right economic conservative -Mr. Duque- which should be welcome by markets and allowing for the current expansion to continue.
In Mexico, presidential candidate Lopez Obrador is consolidating his lead, generating anxiety, uncertainty and pressure on the currency market.
Finally, in Brazil, ex-President Lula’s chances for a potential run should to have come to an end with the Superior Electoral Court (TSE) rejecting his appeal and ordering his arrest. With Lula out of the race, the probabilities of a left wing populist candidate fall significantly in our view. This race is still in its very early stages but as of this writing the chances for a moderate center right candidate have increased but are far from guaranteed.
While we recognize that at the margin the risk adjusted return is not as attractive as before, the GIC maintains its positive outlook for Latam markets given attractive absolute and relative valuations while keeping an eye on political events that might disrupt the broad view.
We are overweight Brazil, Argentina and Colombia and market weight Mexico, Chile and Peru. We recommend an overweight exposure in local markets, equities and external debt. Our view on the region’s nominal FX basket is neutral.
The main risks for market performance in the region are broadly exogenous but with pockets of localized political risk. Continued developed equity market weakness could negatively impact absolute Latam returns.