Latin America has poor start to year

Emerging markets outperformed the developed world in January with one important exception: Latin America.

Fernando Luque 09.02.2004
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Fears of an earlier than expected rise in American interest rates and concerns about inflation in Brazil explain this underperformance. But while much of the region did poorly Mexico performed relatively well.

Emerging country stockmarkets had an extraordinary 2003 with the MSCI Emerging Markets index gaining 51.6% in dollars terms compared with 30.8% for the MSCI World. The return for the MSCI Latin America index was even better with a rise of 67.1%.

There are several reasons for this outperformance in 2003. First, the American recovery has benefited all emerging markets. But the weak dollar and the demand for commodities such

as iron ore in Asia have been particularly beneficial for countries such as Brazil.

Perhaps more importantly sentiment towards the region has improved. At the start of 2002 few fund managers had confidence in the region’s recovery. A look back at the Morningstar European Trend Survey from December 2002 shows that Latin America was the least favoured region. Concern about its economic and political situation was rife. Argentina had just defaulted on its debt and Brazil had a new President, Lula da Silva, who unnerved the financial markets.

More recently the region has begun to gain supporters. In last month’s Morningstar fund trends survey the percentage of managers expecting the region to be the best performer over the coming 12 months was 13% compared with 7% in December 2003.

Brazil decline

So far this year Latin markets have performed poorly. The regional index gained only 0.5% in January compared with a 1.5% for the World index and 3.3% for the emerging markets as a whole. Brazil’s performance accounted for the region’s poor performance with the MSCI Brazil falling by 4.5% in January.

The idea that the Federal Reserve may raise interest rates sooner than most analysts had expected hit Brazil as higher interest rates in America would make investments in the country less attractive (Brazil still depends heavily on foreign capital).

But there is another fundamental reason for the underperformance of the Brazilian market. The central bank is concerned about a rise in inflation partly provoked by its aggressive cuts in interest rates. It has cut rates over the past eight months to the current level of 16.5%, their lowest for two years.

The central bank hopes to reduce the annual inflation rate to 5.5% this year from 9.3% at the end of last year. To achieve this objective most analysts say that it will temporarily be forced to stop reducing rates. This was confirmed on January 21st when the central bank took most analysts by surprise by leaving interest rates unchanged. But there are fears that the still relatively tight monetary policy could damage the country’s economic recovery.

However, analysts still generally consider the Brazilian market to be undervalued compared with developed markets. Morgan Stanley, an investment bank, says that Brazil is likely to benefit from high global liquidity, low risk aversion and rising commodity prices. Currently the bank says that the Brazilian market is trading near its average historical valuation.

Mexico uncertainty

Mexico was the weakest market in the region in 2003 with a gain of only 29.8%, According to Mark Mobius, the head of emerging markets at Franklin Templeton, Mexico lagged the rest of Latin America because of the uncertainties surrounding the competitiveness of its economy (the country is suffering from strong competition from China) and the slow progress on the implementation of key structural reforms. But he says the country should benefit from accelerating growth in America, its main trading partner.

This optimism explains the performance of the Mexican stockmarket during January with the MSCI Mexico index climbing 8.5%.

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Fernando Luque

Fernando Luque  es el Senior Financial Editor de

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