SUMMARY
Latin American financial markets outperformed in the first quarter of 2022 boosted by the tailwinds of higher commodities prices. However, the recent sharp equity market gains may have limited potential upside.
- The Latam MSCI gained 26% in the first quarter of 2022. Major currencies were up between 3% and 17%, generating positive domestic fixed income returns in USD terms. USD denominated bonds did not fare as well, down around 5% under the pressure of rising USD interest rates.
- Why the rally? The positive momentum began well ahead of the Russia-Ukraine conflict, which accelerated an already strong commodity market. We believe this outperformance was catalyzed by the combination of extremely discounted valuations relative to fundamentals, heightened political fears and very light portfolio positioning going into year-end 2021.
- Latin America is a net exporter of commodities and that was reflected in the performance. But at the individual country level, less diversified exporters could also import commodity inflation. At the margin, regional fundamentals should benefit from the tail winds of higher commodity prices.
- We do not expect, however, a repeat of 2002-2012 when the region grew on average 4.18% p.a. After the 4.9% post-Covid GDP rebound of 2021, consensus growth for the region for 2022 and then 2023 stands at only around 2%.
- While we look for inflation measures to moderate in the second quarter of the year, we expect them to remain elevated relative to recent years. This environment of low growth and higher inflation will present challenges to policy makers.
- Monetary policy continues to tighten, although we expect these cycles to end this year. Fiscal policy space is limited, at least not without putting further pressure on inflation and long-term growth. Political and social dynamics will continue to be key domestic drivers. With most of the region having made a clear turn towards populism, public balance sheets and monetary orthodoxy will be the key variables to monitor when trying to gauge medium-term economic prospects.
- Global Investment Committee (GIC) Asset Allocation driven portfolios are fully invested in the region. While we highlighted attractive valuations in our Outlook 2022, we failed to overweight the region as we argued that value alone was seldom a catalyst for the type of rally seen during the first quarter of this year, especially with the level of uncertainty global financial markets were digesting. It happens we were wrong. Nevertheless, our Asset Allocation portfolios benefited from positive returns. At current levels we feel comfortable with our core index neutral exposure.
- Opportunistic, non-core, positioning – where we have been more sanguine – could be trimmed from their higher levels of exposure, in our view. We see signs of more crowded exposure and while we are not bearish on these markets, the sharp first quarter gains in equity and currency markets suggest increasingly limited potential upside.
