It may be springtime in South America, but the climate for equity investing has turned noticeably colder.
Chilling economic winds from Asia have tempered -- at least for now -- the appeal of Latin America's stock markets, which fell recently amid the global tumult. Now, investors can understandably wonder: is history repeating itself in Latin America -- just three years after the Mexican peso crisis? Or, is the downturn just a temporary setback?
The woes of the October-November period provided reason for concern. As the crisis struck hard in October, data from Morgan Stanley Capital International, New York, show double-digit declines for that month in dollar terms for most Latin American markets (except Colombia's, which fell only 1%). Brazil's stock market, the hardest-hit in the region, tumbled 24.2% for the month, according to MSCI data.
Overall, for the year through Nov. 11, the MSCI Emerging Markets Free Latin America index stood 14.81% higher. Specific gains ranged from a mere 4.08% advance for Argentina's market to the 43.06% jump by Colombia's. And Brazil's market -- a high flyer earlier in the year -- had year-to-date gains of only 8.3% by Nov. 11, according to MSCI data.
Investors are leery
Given the whacking that occurred, it's no wonder some investors have backed off. In some cases, mutual fund managers took some profits to pay for redemptions; in other cases, investors worried about future prospects. Paul White, international portfolio manager of the Atlantic Richfield Co. pension fund in Los Angeles, responded to the upheavals by raising cash over the past month. Mr. White now has a 20-25% cash holding in ARCO's approximately $20 million Latin American regional portfolio. In contrast, Mr. White said he was "bullish" on the region "a couple of months ago before all the problems in Asia."
Evidence suggests foreign investors wouldn't have been the only ones affected by the local market drops. For instance, some Latin American pension funds also had sizable equities holdings. Most recent data from PrimAmerica Consultores in Santiago, Chile, show that Chilean funds averaged 32% in (mostly domestic) equities as of August. In addition, Argentine pension funds had 25.9% in domestic equities as of June; and Peruvian funds had 35% in local equities as of July. Data from another source show that Brazil's private pension funds have 32% in equities, including privatization issues.
Brazil's fate will affect region
At this juncture, many regional Latin America investors worry most about Brazil's market -- whose fate could affect the entire region next year. Perceived as having an overvalued currency -- due to current account and fiscal deficits -- Brazil has caught the eye of currency speculators. To ward them off, Brazil's central bank roughly doubled interest rates recently. And this month, the government unveiled a fiscal package aimed at raising U.S.$18.2 billion (2.5% of gross domestic product) from spending cuts and higher taxes.
At this point, experts debate whether the Brazilian real will undergo a devaluation. Experts believe it could come under pressure from speculators if Asian currencies decline further; but if turmoil eases in Asia, the Brazilian real would face less risk of devaluation.
Still, recent emergency measures -- especially the higher interest rates -- should slow Brazil's economic growth next year. While growth estimates seem to run in the 1%-2% range next year, some fear the country could tip into a recession.
Public sector is favored
But even with these forecasts, Brazil's stock market hasn't become a lost cause for some investors. While some see a cloud over the corporate sector -- amid expectations of lowered earnings -- a number of investors still like the public sector. Specifically favored: stocks in such high-growth areas as telecommunications and electric power companies.
Outside of Brazil, neighboring markets, especially Argentina's, may struggle next year. Reduced trade with Brazil -- South America's giant -- should eat into profits for companies with hefty Brazilian trade.
But within the region, some markets appear better positioned than others.
For instance, Mexico's market is now seen as the brightest light of the major Latin American markets. There, investors see attractive stock valuations and less economic risk than in Brazil.
Some analysts forecast as much as 6.5% economic growth for Mexico in 1998 -- which would slightly exceed this year's expected level.
Mexico dependent on the U.S.
Perhaps most importantly, Mexico's economy is highly focused and dependent on the U.S. business climate. As ARCO's Mr. White summarized, "Because of its strong U.S. ties and floating rate currency, Mexico has advantages over some of the other emerging countries." Mexico's market comprises about 28% of ARCO's Latin American portfolio, making it the single largest country exposure.
A number of other investors echo the pro-Mexico theme. For example, Martin Currie Investment Management Ltd. Edinburgh, Scotland, "remains overweight in Mexico" in a global emerging markets portfolio "and has done so since the third quarter of last year," said Tristan Clube, a director.
The firm was drawn there because "of the prospects for economic recovery across the region . . . over the 12 months from last year's third quarter, and with that improvement, the prospect for corporate profitability, which has come through across most sectors of Mexico," he said.
At this point, Martin Currie believes: "The recovery will continue in Mexico, however blunted by the recent events in capital markets and the fact that interest rates will have to rise across the region," Mr. Clube said. That -- along with the market's attractive valuations -- "is why we're staying with our position in Mexico." Among the Mexican stocks Martin Currie holds: Cifra, S.A. de C.V. and Telefonos de Mexico.
James Graham-Maw, global portfolio manager with Foreign & Colonial Emerging Markets Ltd. in London, said the firm "is holding its overweighted position in Latin America" in the global emerging markets portfolio. He pointed out that Latin markets now have the double attraction of cheaper valuations and, in Brazil, improving economic policies.
Opportunities ahead
Looking ahead, Mr. Graham-Maw predicts the region is going to have "a short, painful learning experience (and then) in coming months, there are going to be good investment opportunities."
Jane Hackham, investment director of Beta Funds Ltd., London, is among those who see opportunities ahead in Latin America. By the end of the third quarter, she had become underweighted to Latin America -- from a neutral-to-slightly overweighted position previously -- in the global emerging markets portfolio. But now that markets have slid, her perspective has changed. Excluding Brazil, "the rest of Latin America looks particularly attractive," she said.
Her view for next year is mostly positive. "I think if U.S. interest rates don't go up sharply, and if we don't have another exogenous shock like the one this year in Asia, Latin American markets should be higher than they are now. So I will average into the markets and eventually return to an overweighted position -- provided Brazil doesn't collapse," Ms. Hackham said.
The Montgomery Latin America Fund of Montgomery Asset Management, San Francisco, has its biggest overweighted position -- 3.4% of the fund -- in Venezuela's market. But its single largest bets are in, respectively, Brazil, with 47% and Mexico, with a 31% exposure.
Portfolio manager Jesus Isidoro Duarte believes that market volatility in the region has already eased somewhat from the recent big heaves -- where intraday swings of as much as 14% up or down occurred. But to him, it's "still too early to tell if a big rebound" is in the making. Particularly in Brazil's case, the "tough medicine" will take time "to work its way through the system.
But as economic growth resumes and confidence rises, investors should again notice the region's above-average growth prospects, Mr. Duarte believes. The lingering question, he said, is when they'll come back in.
