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It’s been a challenging period for Latin America, but investors may be surprised by the strength of the economic recovery, says Ed Kuczma, Co-Manager of the BlackRock Latin American Investment Trust plc.
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Much like the rest of the world, Latin America hasn’t been impervious to the economic impact of coronavirus. And though problems remain, there are reasons to be more optimistic about the recovery ahead as low interest rates, a weak dollar, and fiscal stimulus measures across the globe create the right conditions for recovery.
Latin American economies bottomed in April/May amid social mobility restrictions imposed as a result of COVID-19. More recently, governments have begun to gradually open their economies, albeit at different rates, as the number of new cases starts to stabilise. Digging deeper into the data across the region, Brazil has experienced a relatively shallow slowdown, while Peru’s economy has been hit hardest. Monthly economic indicators highlight that Brazil was the best performing economy in Q2, whilst also showing it suffered the shallowest drop in output during the pandemic aside from Chile, which was helped by a low base of comparison due to the social protests that took place in the country last year1.
The various government responses in Latin America have been matched by the differing rates of recovery in each economy. We would attribute Brazil's relative success at cushioning the economic impact of the pandemic to the government's aggressive fiscal programmes, including the 'corona voucher' transfer to low income families which, by our estimates, is the largest of its type in the region (at an estimated 3.5% of GDP, versus 1.5%, 1.1% and 0.7% of GDP in Chile, Peru, and Colombia respectively)2. In fact, Brazil is the only country where consensus GDP growth estimates for 2020 have started to improve. Peru, on the other hand, remained the worst performing economy during the pandemic, having imposed the strictest shutdown in the region - though the recovery since is also the sharpest now that the country has started to reopen. Mexico, meanwhile, has bucked the trend of large fiscal countercyclical spending, but despite not performing visibly worse than Colombia or Argentina, some Q3 indicators do potentially suggest a shallower recovery than elsewhere3.
Microeconomic data
In regards to how the economic recovery translates to companies and sectors to invest in, there is progress. Looking at retail sales as an indicator of household consumption, results could arguably validate the success of government programmes in Brazil: for instance, retail sales in June were back to their 6-month average pre-crisis levels, whereas other countries were at least 15% below that level in June4. In terms of industrial production, Chile stands out as having experienced the shallowest recession, but that is largely explained by favourable base effects and the fact mining production never came to a halt, as it did in Peru. Mexico was late to see an improvement in manufacturing, having kept many factories closed through May, but is now seeing a rapid convergence to “normality”. There has also been a strong rebound in the construction sector, particularly in Peru and Colombia, after activity was brought to a halt in April.
There are intuitive reasons behind this recent strength. Interest rates in Brazil have been cut to 2.25%3, for example, which creates a better climate for borrowing and is acting to stimulate the economy. Mexican rates are currently at their lowest level since 20164. At the same time, currencies in both countries have stabilized versus the dollar.
Equally, market reform is still ongoing in Brazil. Progress has been hit by the virus, but the administration is still aiming to tackle the bureaucracy and red tape that holds back economic growth.
Mixed fortunes
Brazil’s aggressive fiscal programmes have supported growth but there are costs associated with this stimulus. While government support for low-income families has been economically successful, it will also increase the primary budget deficit and gross debt to challenging levels. With the need to reduce spending, the government is debating a redesign of some of its income and social policies for next year, aiming to help diminish the government deficit by 2021 and partially curbing the public debt trajectory. While there are risks to the medium-term fiscal outlook, a too-fast decrease in fiscal support could also threaten the recovery next year. The economy’s ability to balance between fiscal sustainability and a fiscal cliff of rapid spending contraction will be the challenge for the economy going forward. However, given the recent strength in consumption-related numbers and business leading indicators, 2020 growth forecasts have been revised upwards by economists and a robust recovery is expected for 2021.
In terms of how we are responding to the recovery, we are positive on materials, particularly commodity exporters in Brazil, plus copper and lithium miners in Chile. We have also been adding to Brazilian homebuilders as they look oversold: lower-for-longer interest rates help make mortgages more affordable and there is still some pent-up demand and a structural housing deficit in Brazil.
Capital market stocks, such as stock exchanges could benefit from record low interest rates, as retail investors and institutions shift capital allocations away from fixed income and into equities. In retail, we have become more cautious on some apparel companies, instead, steering the portfolio toward e-commerce names and retailers with advanced omnichannel solutions to address rapidly evolving consumer shopping habits.
Latin American economies are far from out of the woods, but there are promising signs of recovery. We believe this will be increasingly reflected in market valuations as we see greater flows into Latin American equities.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of October 2020 and may change as subsequent conditions vary.
For more information on this Trust and how to access the opportunities presented by Latin American markets, please visit www.blackrock.com/uk/brla
1- Statista, October 2020
2-The Brazilian Report, March 2020
3- Moody’s analytics, October 2020
4- Reuters, August 2020
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