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Neptune’s Smith: Why Latin America is becoming increasingly market-friendly

11 April 2017

Thomas Smith, manager of the Neptune Latin America fund, discusses of reform on Latin America, where governments are becoming increasingly market-friendly.

By Thomas Smith,

Neptune Investment Management

Latin America is a continent with abundant natural resources.

The region produces over 50 per cent of soy beans globally, has nearly one fifth of the world’s arable land and over a third of freshwater reserves.

Given these statistics, we believe Latin America’s importance in global food production will only increase over time.

Led by Chile and Peru, Latin America also accounts for over 40 per cent of copper production and reserves.

Chile accounts for over 50 per cent of lithium reserves, with Argentina adding a further 14 per cent. As electric vehicles become mainstream, demand for lithium is expected to increase exponentially.

Mexico, Chile and Peru together make up 40 per cent of silver production and nearly 50 per cent of reserves.

Therefore, although the commodity super-cycle of the 2000s may be over, we believe global demand for these metals will continue to rise and that Latin America will be of critical importance to support the economic growth and urbanisation across emerging markets, particularly in India and Africa.

While commodities have been an important source of economic growth for the region, more recently consumption has become increasingly important as millions have been pulled out of poverty and the middle class has boomed.

Performance of MSCI Latin America index over 3yrs

 

Source: FE Analytics

Between 2001 and 2015, more than 40 million people in Brazil entered the middle class, making it the biggest social group in the country, representing half of the country’s total population. The government’s focus on reducing inequality and reducing levels of poverty will continue to support social migration.

This is linked to political risk, which appears to be on the rise globally due to a shift to the left in many developed countries. Latin America, however, is moving the opposite direction.

Structural reforms are now top of the agenda as governments move away from the populist tendencies of the past, and look to raise productivity and increase economic activity.

Argentina and Brazil are the two best examples, with the election of Mauricio Macri in Argentina in late 2015, and the impeachment of Dilma Rousseff in Brazil allowing Michel Temer to become president during 2016 and pursue an aggressive reform agenda. We have also seen a pro-business president elected in Peru, and expect Chile to follow suit later this year.

Reforms in Brazil have been progressing at an unprecedented rate since Michel Temer became president.

The government has very high levels of support in Congress and reform momentum remains strong with a wide-ranging reform agenda to be implemented in 2017.

The Pension Reform is the most significant, which aims to address the pressure that pension contributions are putting on government finances. The current system is unsustainable and a successful reform should help Brazil regain its investment grade credit rating. This could be passed as early as June, although the third quarter looks more likely in our opinion.

Alongside the structural reforms, the economy has bottomed and we are seeing nascent signs of recovery.

Business and consumer confidence have picked up significantly in recent quarters, and this year Brazil will emerge from its deepest recession in decades.

The initial reforms and a stronger currency have helped to anchor inflation expectations which in turn will allow the central bank to lower interest rates and support an investment led economic recovery.

This economic recovery should feed through into strong earnings growth. Earnings have collapsed in Brazil over the past five years, and we expect to see operating leverage drive a sharp recovery as economic conditions normalise and activity accelerates.

In Argentina, Mauricio Macri is returning to orthodox economic policies following years of distortion under the Cristina Kirchner governments. He has already moved quickly to remove capital controls, repay holdouts and return Argentina to the international capital markets.

Next up, rebalancing utility tariffs will be a key step to lower subsidies and reduce the budget deficit. However, there are still distortions present across the economy and, as normalisation progresses, there are opportunities across a range of sectors including banks, utilities and agriculture.

Thomas Smith is manager of the Neptune Latin America fund. The views expressed above are his own and should not be taken as investment advice.

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