SOUTH AMERICA’S SUSPECT REVIVAL
Region’s recent stock market gains aren’t necessarily on solid ground
A casual look at financial markets these days might lead you to think that South America is on a roll.
In Brazil, the Bovespa index has risen more than 40 per cent in the past three months. In Peru, the S&P Lima General index is up by 50 per cent over the same period, while Argentina’s Merval index is up by nearly the same proportion.
In fact, Argentina just issued its first sovereign debt after 15 years of banishment from international debt markets — a banishment, you might remember, brought on by the country’s spectacular US$95 billion default in 2001.
How times have changed. On Tuesday, Argentina floated US$16.5 billion in new bonds, and the issue was oversold, with demand of nearly US$70 billion. The 10-year notes yield 7.5 per cent — more than a full percentage point less than debt from other countries with B- credit ratings from Standard & Poor’s. All in, Argentina’s float was the largest in the history of developing markets.
That kind of action might catch the attention of any investor looking for returns in a yield-deprived world. Indeed, the performance of the Bovespa/Lima/ Merval trio makes the S&P/TSX composite index and its 18 per cent return in the past three months look downright anemic.
But if you’re tempted to put your money into this seeming resurrection, you might want to look a little more closely first — and remember that not all South American economies are the same, as much as a rising tide lifts all boats.
That tide is the general uplift in emerging market equities over the past few months. The MSCI Emerging Market Index has risen by more than 20 per cent since mid-to-late January, driven by the weaker U.S. dollar and dovish signals from the Federal Reserve.
Emerging markets are heavily exposed to rising U.S. interest rates because they hold so much U.S.-dollar-denominated debt. If the greenback goes up, as happens when the central bank tightens, then they lose.
Because of that, emerging markets were heavily punished in the immediate wake of the Fed’s December rate hike, and the recent surge in EM assets is an indication of just how far from favour they had fallen: the oneyear return of the MSCI index is still -17.7 per cent.
There are other, more local factors behind the South American rallies.
For instance, in Brazil, investors have cheered the evolving impeachment proceedings against President Dilma Rousseff for fudging budget numbers.
There is little doubt that Rousseff has proven to be ineffective, economically. Brazil is now in the midst of a prolonged and perhaps chronic recession. The International Monetary Fund expects the economy to contract by 3.8 per cent this year. Unemployment is in the double digits. Inflation is running at more than nine per cent. Government coffers, meanwhile, are running dry, and would-be successors to Rousseff are contemplating tax hikes — the last thing a shrinking economy needs.
Peru, by contrast, seems a bastion of stability. In the current presidential race, which will culminate in a June election, both candidates are pledging to stay the course that has seen Peru enjoy years of GDP growth and contained inflation. But over the long term, there are a host of problems — poor health care, high poverty rates, rising crime — that could well undermine Peru’s political and economic stability.
As for Argentina, a political refresh is fuelling its new-found popularity among investors. Newly minted President Mauricio Macri has vowed economic reform, including settling outstanding debts, devaluing the currency and cutting taxes.
Yet Argentina, like Brazil, has a hole to climb out of. Unemployment is high, inflation is running at nearly 20 per cent, and the economy is in recession. “Macri-nomics” might roll off the tongues of investors looking for the next big thing, but we’ve seen how political flavours of the day can soon lose their lustre (Abenomics, anyone?) when it comes to turning economies around.
That huge bond issue, by the way, may depend as much on monetary policy elsewhere as the Argentine economy does. One reason the 7.5 per cent yield is so attractive is that yields are so low everywhere else.
Investors should also bear in mind what Argentina plans to do with that US$12.5 billion it just raised: $10 billion of it is going to pay back some of what the country owes creditors from the last time it defaulted. In effect, it’s taking on debt (at bargain basement rates, relatively speaking) to pay off debt. If Macri fails, or the greenback recovers — well, draw your own conclusions.
For now, anyone betting on South American markets had better pray that Janet Yellen maintains her dovish ways.