Latin American funds have been top performers since the start of the year, buoyed by rising commodity prices and currency strength. But will difficult politics disrupt the region’s strength?
- The immediate catalyst for the strong performance from the Latin American sector is high commodity prices
- Currencies are also strong, buoyed by the region’s higher interest rates
- Politics and a weakening consumer may disrupt this benign picture
There are just four sectors that has delivered a positive return since the start of the year – Latin America, Commodities, UK Direct Property and Infrastructure. Of those, Latin American funds sit head and shoulders above the rest. It is quite a turnaround for a sector that has been in the doldrums for the past three years. Can it last?
The immediate catalyst for the strong performance from the Latin American sector is high commodity prices. The prices of Brazil’s main exports - oil, soybeans and iron ore – have jumped higher since the start of the year. Mexico is a significant beneficiary of high oil prices, while Chile and Peru make up around one-third of all global copper production, where demand is also rocketing.
However, this is not the only catalyst. Latin American currencies have soared. This is partly from commodities demand, but also because central banks across the region have raised interest rates. This is particularly evident in Brazil, where borrowing costs have increased to 10.75%, the highest in almost five years. International investors are gravitating to the region’s currencies in search of higher yields.
The final element in Latin America’s favour was price. Valuations across the region are cheap after several years of underperformance. The region is benefiting from some reallocation of emerging market capital, which is exiting Russia and, to some extent, China.
For the time being, there is little to interrupt this benign environment for Latin America. Until there is a de-escalation of the war in Ukraine, commodity prices are likely to remain high. Supply chain disruption is also likely to persist, keeping prices elevated. This should continue to support currencies across the region. Equally, the differential in interest rates between Latin American countries and the rest of the world is likely to continue.
However, the region’s erratic politics could rear their head again this year. There are elections in Brazil, which could see the return of left-leaning Luiz Inácio Lula da Silva. Left-leaning governments have also been elected in Chile and Peru, with the promise of renationalisation and higher taxes. Historically, this flavour of politics has often prompted volatility in Latin American markets.
Equally, there are a lot of other sectors that may not benefit from the rise in commodities. For example, it could dent consumer spending as households are forced to spend more on energy bills. This may stall economic recovery across the region. Valuations are still cheap, but there are reasons to be cautious on Latin American markets from here.
