Latin American markets: shot in the arm required

Latin American equity indices have trailed the rest of the world, including emerging markets, for the past year. Yet prices for the region’s important commodity exports remain high. Time to take advantage of undervalued stocks? Not so fast. Latin America’s markets lack the pull they once had.

The rise in competition from one of Latin America’s biggest export customers, China, has cut back emerging market investor interest in the region. Earlier this century, Latin American countries profitably exported raw materials to sate China’s voracious industrial appetite. By 2010, Brazil represented more than 16 per cent of the MSCI Emerging Market benchmark. Today it has only a quarter of that weighting, point out analysts at Tellimer, as more Chinese constituents join MSCI indices.

Even so, with commodity prices doing so well, one might expect more demand for Latin American stocks. Copper, up by three-quarters in price over one year, made up 46 per cent of Chile’s export value pre-pandemic. In Brazil, soyabeans, iron ore and crude oil together accounted for almost the same proportion of exports.

The problem is deciding where prices go from here. There is no clear evidence that a new commodity supercycle has begun and China is attempting to temper further commodity price surges. No surprise that MSCI Latin America trails the broader emerging market index by 11 percentage points over one year.

Valuation presents an additional hurdle. Latin America’s price to book is more than 2 times — slightly higher than its five-year average. Brazil is no cheaper, and interest rates there are rising. Pandemic-induced goods shortages have led to prices increasing, up 6 per cent overall in the year to March. Brazil could also be the source of further regional Covid-19 cases given it shares porous borders with ten countries. Its vaccination effort has covered only about 3 per cent of its population, according to Financial Times data. The government of President Jair Bolsonaro has rejected calls for a lockdown.

Commodity prices should soon peak. This possibility, combined with the surge of Covid-19 cases, mean that it is too early to fill portfolios with Latin American stocks.

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