Last updated: 16:30 / Tuesday, 10 November 2015
Report by Credit Suisse

Sentiment Improving, but Not Fundamentals in LatAm

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Sentiment Improving, but Not Fundamentals in LatAm
  • Fed’s decision to postpone hikes leads to cautious optimism for emerging markets investor
  • Latin America is by far the lagging region, underperforming both global emerging markets and developed market equities by 2.7% and 0.6%, respectively, in local currency terms
  • Manufacturing activity in Mexico cools down considerably

In the monthly Latin America Investment Strategy report from Credit Suisse, Philipp E Lisibach, director of Credit Suisse in the private banking and wealth management division, discusses on how the Fed´s decision to postpone hikes on interest rates has given a break to Latin American economies. However, economic indicators such as production rate or inflation, are not showing values close to the economic recovery path.      

“The decision of the Federal Open Market Committee (FOMC) on 17 September to postpone the initial US Fed funds rate hike has triggered concerns about the health of global economic growth and led to a significant cool-down of investors’ risk appetite and a spike in volatility in the capital markets. Emerging market (EM) equities typically behave rather poorly in this type of environment, as their sensitivity to global economic growth is high. While the initial reaction was similar this time, the decision to delay US interest rate hikes has led to cautious optimism for EM investors as the negative side effects of a potential hike (including a likely strengthening of the US dollar, a potential withdrawal of liquidity, and local central banks forced to follow suit and hike interest rates) have been delayed and so the results have been marginally beneficial”, said Lisibach.

Oversold sentiment corrected

After seeing value appearing in emerging markets equities and sentiment seeming to be oversold shortly after the FOMC decision, the Credit Suisse Investment Committee changed its previous underperform view for emerging market equities to neutral on 23 September. In a sharp recovery, emerging markets equities have outperformed developed market equities from 23 September through 21 October. However, Latin America is by far the lagging region, underperforming both global EM and developed market equities by 2.7% and 0.6%, respectively, in local currency terms. The laggard within the region has been Mexico, which continues to be one of the better-performing markets in Latin America on a year-to-date basis, although it has lost some of its momentum recently.

Mexico’s high valuation meets with slowing momentum

Mexico’s manufacturing activityhas cooled down considerably and, with a September manufacturing index reading of 50.1, it is just about at the inflection point between expansion and contraction, which stands at 50 (see chart).

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Mexican leading indicator signals lower manufacturing activity

Earnings momentum, measured by the 1-month and 3-month change in consensus expectations for the MSCI Mexico index, has turned negative again, yet Mexico’s lofty earnings growth estimates remain the highest in the region at almost 21% for the next 12 months. “We think the pressure may persist to further adjust already high expectations and the rich valuation downward, thus leading to headwinds for prices. As a result, we maintain our underperform view versus global EM equity”, adds Lisibach (see Table 1 for a full overview).

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Latin America equity strategy, Credit Suisse

Mexican leading indicator signals lower manufacturing activity

The MSCI Mexico Index is designed to measure the performance of the large and mid-cap segments of the Mexican market. With 28 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Mexico.

Inflation in Brazil not expected to converge to target before 2017

In Brazil, the central bank surprised investors when it announced on 21 October that it does not expect to meet its inflation target of 4.5% in 2016. The weak economy limits the central bank’s ability to fight against the stubbornly elevated level of inflation with higher interest rates, delaying the normalization process. The good news is that inflation seems to have peaked, see chart.

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Inflation in Latin America

Nonetheless, Credit Suisse sees thatBrazil’s growth inflation mix has weakened further and their economists cut Brazil’s GDP growth forecasts to –3.2/–1.2% for 2015/16, and expect a slightly higher average inflation rate in 2016, now at 6.4%.

“While higher interest rates may be a headwind for Brazilian bonds, the generous level of yields should allow bond investors to absorb some of these losses, which is why we maintain our neutral view on Brazilian local currency bonds (see Table 2 for a full overview). We confirm our negative view on Brazilian hard currency bonds and the equity market. The political environment remains very difficult, and corruption investigations and attempts to push out President Rousseff are leaving the government paralyzed, making it unlikely that much-needed policy developments will be implemented in the near term”.

Acceleration of inflation in Colombia due to food and the weak peso

The economy that continues to struggle with accelerating inflation is Colombia, where the consumer price index has increased to 5.4% year-over-year, exceeding expectations and reaching a level not seen in over six years. A pick-up in food prices due to unfavorable weather and the weaker Colombian peso is partially to blame for inflation, as the peso has lost over 29% against the US dollar over the past one year (as of 22 October). The Columbian central bank raised its policy rate by 0.25% and has released a modestly hawkish statement, leading us to believe that further modest rate hikes to tame inflation cannot be ruled out. Consequently, Credit Suisse is changing their view on Columbian local currency bonds from neutral to underperform.

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Latin America fixed income strategy, Credit Suisse
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