December 2, 2011
Latin America, the Land of Opportunity and Caution
By PAUL SULLIVAN
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What happened? Can it be that Latin America is now a solid investment, as the middle class in many of the countries increasingly becomes a driving force? Or is the region’s cycle of booms and busts set to repeat itself?
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Anyone who invested broadly in the region’s main stock indexes has had a bad year. Brazil’s index is down 16 percent, Mexico’s is down 5 percent and Chile’s is down about 16 percent. These numbers are worse for international investors because all three countries’ currencies have fallen against the dollar.
Not surprisingly, investors have been pulling their money out. As of Dec. 2 they had taken $9.8 billion out of Latin America, according to fund flow data compiled by Morgan Stanley research. (Emerging markets in general have not fared well this year, with investors taking out $36.6 billion.)
But, at the same time, companies as diverse as Siemens, General Electric, Nissan and Halliburton have increased their operations in Brazil.
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China is Brazil’s major trading partner, which would seem to augur well. But it is selling commodities like iron ore, which could suffer if China’s growth continued to slow.
Yet Brazil also has a growing consumer sector. Sergio Cabral, the governor of the state of Rio de Janeiro, told me that almost 40 million people in Brazil had entered the middle class in the last five years. (Gerardo Zamorano, a director at Brandes Investment Partners, put that number at 25 million to 30 million, which is still a striking number given that Brazil had almost no middle class when I was there.) And Governor Cabral said that demand for all types of consumer goods was far outstripping supply in his state.
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“Prices are crazy,” he said on a visit to New York this week. “We need more hotels. We have a suite problem — we have demand but we need more supply.”
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That is a good thing as long as inflation does not increase and erode the buying power of the new middle class. Inflation has historically been a huge problem in Brazil, running to triple digits in the 1980s and 1990s. Official estimates now put it at a comparatively low 6.5 percent.
What’s an investor to do, with so many contradictory measures? Here are some thoughts.
THE CHANGE Ten years ago this week, Jim O’Neill, chairman of Goldman Sachs Asset Management, coined the term BRIC, elevating the profile of four countries — Brazil, Russia, India and China — that he thought were poised to become “growth economies.” He argued at the time that these countries contributed 8 percent of global gross domestic product and that in 10 years, their economies would account for about 14 percent. They’re now at 18 to 19 percent.
.Mr. O’Neill said this week that he was surprised at how well Brazil had done, overtaking Italy to become the seventh-largest economy in the world.
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“I found it really easy to be bullish about Brazil over the past decade,” he said. “I describe myself now as being a little bit more reserved. The biggest risk is if inflation were to get out of hand. There is no way you’re going to get the continued increases among the middle class if that happens.”
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By Brazilian standards, he noted, inflation is low. Even if some analysts think it is above the 6.5 percent target rate, the central bank cut interest rates on Wednesday for the third time this year, a sign it is not concerned about inflation.
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Francisco Alzuru, managing director of emerging market research at Hansberger Global Investors, said countries like Brazil and Mexico had reduced their debt-to-G.D.P. ratios significantly in the last decade, to levels better than in the developed world. And both countries, he said, had learned hard lessons from the crises of the 1990s that drove down the value of their currencies and pushed up the cost of borrowing.
“This time, they have growth from the benefit of sound macroeconomic policy,” he said. “I don’t want to imply that Latin America is risk-free and we can invest with our eyes closed. But from a macroeconomic perspective, the boom and bust should be better managed.”
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In a sign of how far Latin American economies have come since the late 1990s, an official in Brazil’s finance ministry said this week that the country would not make any decision on aid to Europe during a visit from the head of the International Monetary Fund. It wasn’t too long ago that Brazil was on the receiving end of such bailouts.
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THE OPPORTUNITIES Jamie Kramer, head of the thematic advisory practice at J. P. Morgan Private Bank, tells her clients interested in investing in Latin America to look for the “emerging markets of the future with their emerging middle class.”
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This is not as easy as it sounds. She noted that exchange-traded funds on the Brazilian index are often heavily weighted with energy and financial services companies, a different bet entirely.
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Mr. Zamorano said he had focused on investing in wireless telecommunications and consumer product companies. He noted that when a consumer was going from $500 in annual income to $800, “you’re still subsistence.” But, he said, “Once you’re getting to $5,000, $10,000 you’re seeing car consumption, broadband, consumer products going up. That’s a phase we’re seeing.”
Mr. Alzuru said there were opportunities to invest in what the middle class in Mexico needed most — housing and all the related industries from mortgages to construction.
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“In the U.S., we have a saturated market,” he said. “In Mexico, the need for houses, the accumulated deficit is in the millions of units. You have 10 years of pending demand for homes.”
THE RISKS Beyond inflation, investors should be wary of any economy significantly dependent on exports.
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The State Department said 80 percent of Mexico’s exports went to the United States in 2010, for instance, and the sluggishness of the American economy had slowed Mexico’s growth. The same fate is feared for Brazil and China. Chile is a big exporter of wine, flour, lithium and copper, while Peru exports various minerals, like copper, silver and gold. Such dependence on exports wreaked havoc in the 1990s.
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There is also political risk. Venezuela, under the leadership of President Hugo Chávez, is economically worse off than it was 10 years ago, despite immense oil wealth. And Argentina is enduring high inflation, 9.8 percent as of October, which many analysts, including Mr. Alzuru, attribute to ineffective government policies.
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But Mr. Zamorano said relatively high interest rates meant the governments had the ability to cut rates to stimulate growth, if needed — something developed countries like the United States or Japan can no longer do.
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Governor Cabral said he was most worried about the slow development of roads, ports and airports in his state and Brazil in general. “In Brazil, for more money to be invested, you have to open more services, concessions, airports,” he said. “I’m concerned Brazil has to speed up the infrastructure to attract more investment.”
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His goal is to wean his state from its dependence on energy, which he recognizes as volatile, and focus more on technology and education.
Back when I was there, Latin America’s economies were hard to tell apart. But now, they present as many opportunities and pitfalls as any other investment.
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