Twilight For Latin American Equity Rally
It is too early to call the peak in Latin American equities, especially when there is so much liquidity floating around. However, recent price action combined with macro concerns imply that another significant downleg may not be far off. Since the start of the year LatAm stocks have been the EM outperformers, but while Risk Watchdog has teetered on turning bullish several markets in recent months, my overriding feeling has been that on the whole these markets have come too far, too fast. Although this view has been reinforced with last week’s capitulation in regional bourses, beyond the short term I have serious question marks about whether there is indeed any value left in regional equities over the next 6–12 months.
A glimpse at regional price–to–earnings ratios tells an interesting story of investor sentiment towards LatAm equities over the past five years. Back in January 2005, the Dow Jones had a higher trailing P/E ratio than all other major regional markets. Five years on and this picture has been reversed, with the Dow now bottom of the pile in valuation terms. Such a reversal in trend is not particularly surprising, since the 2005–2007 period was characterised by increasing appetite for high yield, high-risk EM stocks, and many South American economies managed to weather the post-crisis recession through exposure to Chinese growth, which translated into rapid gains for equities from Q109 onwards.
Yet even with the recent fall in P/E ratios, most regional bourses still remain at or near pre–crisis highs, and in the case of Colombia, equity valuations continue to post new highs, a trend which is not in line with a much weaker external environment.
Good…But Not That Good
While Latin American equities may be justified in trading above their US counterparts, I seriously doubt whether the macro outlook for these economies is better than it was back in the post–crisis, EM heyday. For one, demand for regional exports from the US consumer – a major determinant of Mexican and Colombian economic growth – is incapable of returning to previous highs without banks lending, something that appears highly unlikely in the current environment. Secondly, the precipitous fall in China’s real estate market brings to the fore a double-dip downturn in Chinese growth (a core scenario of Business Monitor’s Asia team), which I believe is yet to be priced into Brazilian, Chilean and perhaps even Peruvian stock markets.
As outlined above, it is too early to say that these markets have now reached their peaks, and I certainly remain bullish towards both the EM and Latin American growth story over the long term. This is particularly true for those economies which meet BMI’s EM checklist criteria; i.e. sound banking sectors, resource wealth, generally market-friendly policies, strong demographics and low levels of private debt. However, such long-term optimism does not justify current equity valuations, which I believe are not currently pricing in a much weaker external environment in the latter stages of this year and into 2011.