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By Murray Coleman
As the U.S. economy flirts with recession and the Federal Reserve's rate-cutting cycle winds down, the hottest stock market for exchange-traded funds faces its stiffest headwinds since late 2002.
That's when Latin America started soaring. A combination of massive price hikes in energy and commodities along with stricter fiscal controls by leading countries has transformed the region.
But for all its advances, Latin America still remains in the shadows of its bigger neighbor to the north. With debate raging about whether the U.S. is yet to reach recessionary levels, the Federal Reserve's move Wednesday to cut short-term interest rates by a quarter-point to 2% is adding fuel to the fire.
Normally, lower rates in the states would bolster prospects for foreign investment. Such moves tend to eat away at the U.S. dollar's value on world markets, which is good news for currencies like the real and peso.
This time, however, Fed policy makers say they're ready to turn their attention to fighting inflation. While their statement following the rate cut didn't go as far as some had hoped in spelling an end to rate cuts, the Fed did emphasize slowing commodities prices and other key inflationary measures as significant events to monitor.
"If the Fed's rate-cutting cycle is over for awhile, the dollar should get a short-term boost," said Joe Clark, managing partner at Financial Enhancement Group LLC. "At the same time, commodities and energy prices likely face stiffer headwinds. As a result, we're expecting Latin American stock ETFs to sell-off in the near-term."
Michael Pento, senior market strategist at Delta Global Advisors in Huntington Beach, Calif., acknowledges strong sentiment in some circles that Latin American stocks will be hurt by recent developments. But he remains optimistic about international stocks in general.
Pento says that the Fed action has already been priced into the market. Indeed, in recent weeks commodities and energy traders have been taking their lumps.
"Consumers and the economy as a whole are both even more leveraged now than when rate cuts began last year," he said. "So it's hard to believe the Fed's in any better position now to start raising rates back to the 5.25% range, which is where we'd probably need to get to see any real strengthening in the dollar."
If any sell-off in Latin American stocks takes place going forward, Pento believes it'll be extremely short-lived. "I'm telling my clients that the fundamentals remain largely in-place for investing in foreign stock markets," he said.
Sole Holdout
But talk of a bubble in Latin America is gaining steam. In the past five years, the average Latin American stock mutual fund has returned an average annualized 44%-plus, easily outdistancing 36 other fund categories tracked by Morningstar Inc. The next closest is Asia ex-Japan at more than 31% per year during the same period.
This year, almost every major region in the world is suffering from the weight of a worldwide credit tightening and slower economic growth in the U.S. The lone exception for stock fund investors has been Latin America, which is up slightly more than 1.6% so far. Among diversified categories, only bear market funds taking inverse positions are above water.
"In the past 15 weeks, about the only things in stocks that have worked to any extent for long investors have been Latin America's materials and energy-rich markets," said Clark, a demographics specialist who uses both technical and fundamental analysis in his independent research.
"For the short- to intermediate-term, though, we're bracing for a real sea change in sentiment by investors regarding the whole region," he added.
The advisor isn't selling his clients' positions of iShares S&P Latin America 40 Index (NYSE: ILF). "We see long-term strength in the region," Clark said. "To us, a downturn now provides us with an opportunity to buy more shares at much more attractive pricing. This is a part of the world we see as worthy of full marriage rather than a short-term fling."
But analysts warn that volatility could increase markedly in coming quarters. The International Monetary Fund has issued a report that finds a slowing U.S. economy is likely to prove a drag on many areas in Latin America. It's also cautioning of the likelihood for a slowing in commodities and raw materials prices, pointing to a possible decline in the next year.
The combination has led the IMF to predict that Latin America's domestic product growth rate will slow by 2% to 3.9% by the end of 2009.
Since those findings were released about two weeks ago, economic leaders across the region have refuted those forecasts. And at least one noted economist, Moody's Alfredo Coutino, has also taken exception to the IMF analysis.
"While certainly no country in the region is immune from what's going on in the U.S., the IMF's conclusions are drawn from historic factors," he said.
The last time a major global downturn hit Latin America was seven years ago. Since then, countries in the region have bolstered their reserves and built large fiscal surpluses, Coutino says.
Much of that has been due to profits in commodities and energy markets. But another major contributor that shouldn't be discounted, Coutino argues, is that Latin American policy makers have been very attentive in controlling debt and managing inflation.
In fact, the region now has become a net exporter, selling more of its goods and services to other parts of the world than it needs to import from outside markets, he points out. "While U.S. economic activity enters a recession, Latin America is moving in the opposite direction," Coutino said. "What we've really seen since the last financial crisis in the region is a decoupling of its economies from the U.S."
Misconceptions abound about the region, agrees Anthony Welch, a money manager and analyst at Sarasota Capital Strategies. "Some countries are shakier than others, but the region isn't as tied to the U.S. economy as a lot of people still believe," he said. "Considering that these are rapidly growing emerging countries and Latin America's abundance of materials and natural resources, I don't see how Latin America can be dragged down too much from a relatively mild downturn in the U.S."
How much Latin America is ready to stand on its own economic footing, Coutino adds, can be seen by market movements in the last half of 2007 and early this year.
In the past, a significant slowdown in the U.S. would start showing an impact in Latin America within three months. While some such as the IMF are expecting such signs to begin showing up in Latin America soon, Coutino observes that the region has maintained its momentum for much longer than during past U.S. slowdowns.
"The important factor is that Latin America's growth has continued for more than six months after signs of a recession showed up in the U.S.," he said.
Private consumption, investment spending both domestically and from foreign interests have continued to produce relatively strong growth numbers through the first quarter, Coutino says.
In the IMF research, Mexico was highlighted as the country most vulnerable to a deeper U.S. recession. The iShares MSCI Mexico Index (NYSE: EWW) is up more than 3% in 2008. "It's going to be impacted, just like everyone else in the region," Coutino said. "But there are two important factors that make it unlikely for Mexico to be as affected as the past."
Mixed Bag
For one, Mexico's fiscal and trade pictures remain quite strong. And also, the government is implementing fiscal stimulus to boost domestic consumption. "Since the beginning of the year, they implemented tax cuts, more subsidies and a huge program of investment in public and private infrastructure," Coutino said.
But he is forecasting moderating growth for Mexico, about flat with last year's 3% rate. "So it's going to be a very mild slowdown," he said.
Still, Latin America lags emerging Asia in terms of industrialization, Coutino says. In fact, if emerging markets are hit by a bigger slowdown in developed parts of the world, he agrees with other economists who are predicting that Latin America likely will suffer more than most of emerging Asia.
But he expects Brazil to remain the region's emerging star for some time. It has been expanding in the past five years with GDP growth averaging about 5% per year. He's forecasting around 4.9% this year compared with 5.4% in 2007.
The iShares MSCI Brazil Index (NYSE: EWZ) has gained around 4% in 2008.
"It has been opening the economy to foreign investment, which has diversified its base," Coutino said. "But it's still behind emerging Asia since there are still some sectors that remain closed. That has restricted the economy's capacity to grow."
Independent manager Welch, who's based outside Sarasota, Fla., has been invested in ILF since August 2006 and doesn't plan to sell any if short-term conditions deteriorate. On his watch list is the new iShares MSCI Chile Index (NYSE: ECH).
"Latin America can be very volatile, so we're staying with the more diversified ILF right now," Welch said. "But if we were just looking at getting into the region for the first time now, we'd probably go with a combination of ECH and EWZ."
Besides holding more than 60% in Brazil, ILF has about another quarter of its stocks in Mexico. That country is the ETF's second-biggest concentration. "We'd just as soon leave Mexico out of the equation right now in terms of investing in Latin America," Welch said.
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This article has 5 comments:
- bluesmoke
- 143 Comments
May 01 01:51 PM- buyitcheap
- 422 Comments
May 02 08:19 AM- CHARLIERAY
- 3 Comments
May 02 12:16 PM- Wez
- 171 Comments
May 02 05:26 PM- peoplsoft
- 6 Comments
May 03 02:00 PMYeah that's a stretch, something's been going up for 5 years and a bubble might be forming...
Bubble's don't form unless something does go up!