Latin American equities can continue to weather political storms - Capital Economics
Capital Daily

Latin American equities can continue to weather political storms

Capital Daily
Written by Oliver Jones

After a week of political turmoil in Latin America, it is striking just how small the overall impact has been for investors in the region’s equities. Even if Peronists sweep to power in Argentina again, and protests rumble on elsewhere, there are reasons to think that the MSCI Latin America Index as a whole will hold up better than some of its regional peers in the next year or so.

  • Fed likely to cut its policy rate by another 25bp as growth disappoints (Wednesday)
  • Euro-zone GDP growth probably slowed to a crawl in Q3 (Thursday)
  • We estimate that US non-farm payrolls rose by just 25,000 in October (Friday)

Key Market Themes

After a week of political turmoil in Latin America, it is striking just how small the overall impact has been for investors in the region’s equities. Even if Peronists sweep to power in Argentina again, and protests rumble on elsewhere, there are reasons to think that the MSCI Latin America Index as a whole will hold up better than some of its regional peers in the next year or so.

This week alone, protests in Bolivia have broken out over Evo Morales’ contested victory in the country’s presidential election; talks between the government and the largest indigenous organisation in Ecuador, which helped end earlier anti-austerity demonstrations, seem to have broken down; and President Piñera’s concessions have failed to quell strikes and unrest in Chile. In the meantime, voters in Argentina are preparing to go to the polls, and look likely to return a Peronist to the Casa Rosada for the first time since 2015.

Despite all of this, at the time of writing the widely-tracked MSCI Latin America Index is up by more than 3% this week in US dollar terms. Partly, that is because the disruption has been concentrated in the smaller, and less financially-integrated, economies in the region. Bolivia and Ecuador are not even included in MSCI’s benchmark index, and Argentina’s share of it is tiny, at less than 2%. Chile’s share is a bit larger, though still not huge, at 8%.

The bigger picture is that Mexico, and particularly Brazil, are the regional heavyweights both economically and in terms of the size of their equity markets. (See Chart 1.) In Brazil, the Bolsonaro administration has this week defied the odds to pass the pension reforms needed to stabilise the country’s public finances. It is notable how little unrest that has caused, given that the country’s pension system will become far less generous as a result.

Chart 1: Country Shares Of MSCI Latin America Index

Sources: Bloomberg, CE

It is also worth remembering that stock markets do not necessarily struggle just because protests are happening – context is key, as we argued here. That might help to explain why equities in Chile, for example, have stabilised since Monday. The country has fairly strong fiscal fundamentals, meaning there is scope for the government to do much more to address demonstrators’ concerns about living costs at least.

As far as the outlook is concerned, we think that there could be yet more pain to come for Argentine assets following a Fernández-Fernández victory in the election. And it is fair to say that a lot of good news on President Bolsonaro’s broader economic reform agenda in Brazil is already discounted. But even allowing for that – plus the possibility that the protests in the Andean economies continue – we think that the MSCI Latin America Index will not fare as badly as its EM Asian counterpart. The latter is even more vulnerable to the further escalation of the US-China trade war, and slowdown in China’s economy that we are anticipating in the coming quarters. (Oliver Jones)

Selected Data & Events

GMT

Previous*

Median*

CE Forecasts*

Wed 30th

US

GDP (Q3, 1st Est., q/q ann.)

12.30

+2.0%

+1.6%

+1.5%

US

Fed Policy Announcement

18.00

1.75-2.00%

1.50-1.75%

1.50-1.75%

Thu 31st

EZ

GDP (Q3, Prel. Flash, q/q(y/y))

10.00

+0.2%(+1.2%)

+0.1%(+1.1%)

+0.1%(+1.0%)

Fri 1st Nov

US

Change in Non-Farm Payrolls (Oct)

12.30

136,000

95,000

+25,000

*m/m(y/y) unless otherwise stated; p = provisional

Key Data & Events

US

We think that the Fed will cut interest rates again on Wednesday. Officials have shown no signs of pushing back on market expectations for looser policy. On the data front, we estimate that GDP growth fell to 1.5% annualised in Q3, from 2.0%, as a slowdown in household and government consumption growth was compounded by further drags from inventories and net external demand. Meanwhile, we expect both nominal and real personal spending figures for September to have increased by 0.1% m/m. We also calculate that non-farm payrolls rose by just 25,000 in October, mainly reflecting disruption caused by the strike at GM. And finally, after slumping to a decade-low of 47.8 in September, our model suggests that the ISM manufacturing index will rebound to 50.5 in October. That would echo the stabilisation seen in recent months in the other manufacturing surveys, but would still be consistent with economic growth slowing further in the fourth quarter. (Michael Pearce)

Europe

The October Ifo Business Climate Index was unchanged at a very low level, suggesting that Germany’s economy remained weak at the start of Q4. And GDP data are likely to show that growth slowed across the other major euro-zone economies and that the bloc as a whole stagnated last quarter. Otherwise, we think that euro-zone core inflation held steady in October. But Switzerland’s inflation probably fell back into negative territory, which will further bolster the SNB’s dovish stance.

In the UK, the Prime Minister is likely to lose a vote to hold a general election on Monday. Following that, we expect the EU to announce that Brexit will be delayed until 31st January. Meanwhile, the release of October’s manufacturing PMI will probably show that industry is still struggling. (Melanie Debono & Thomas Pugh)

Other Developed Markets

We think that the Bank of Canada will keep its policy settings unchanged at its meeting on Wednesday. But we expect the Bank to strike a dovish tone, given the ongoing weakness of the domestic and international business surveys. On the data front, we estimate that GDP rose by 0.2% m/m in August.

In Australia, we think that headline inflation eased to 1.4% in Q3, from 1.6% in Q2.

Meanwhile, amid continued concerns about the impact of loose policy on financial stability, we expect the Bank of Japan to leave its short-term policy rate unchanged. We suspect policymakers will instead try to steepen the yield curve by shifting bond purchases towards shorter maturities. Otherwise, we think that retail sales rose sharply in September ahead of the tax hike, while the unemployment rate edged up. (Stephen Brown, Ben Udy & Tom Learmouth)

China

The main upcoming event is the fourth plenum of the Central Committee of the Chinese Communist Party. Meanwhile, the PMIs will probably show that momentum in the manufacturing, services and construction sectors weakened in October. (Sheana Yue)

Other Emerging Markets

In Emerging Asia, we think that Taiwan’s GDP expanded by 3.0% in Q3. Meanwhile, the October PMIs are likely to confirm that the manufacturing sector across Emerging Asia remains in the doldrums.

In Emerging Europe, Russia’s central bank cut its policy rate by 50bp to 6.50% on Friday, and the dovish tone of the accompanying statement support our view that the easing cycle has further to run. We expect the one-week repo rate to be cut to 6.00% by early 2020, which is lower than investors are currently anticipating. As for the forthcoming data, Poland’s inflation is likely to have edged up in October. Meanwhile, manufacturing PMIs for October are likely to provide more evidence that Turkey’s economy gathered pace, while industry in Central Europe continued to struggle.

In Latin America, Argentina’s general election takes place on Sunday. Peronist opposition leader Alberto Fernández is widely expected to win. While Mr Fernández has been unclear on his economic policies, we think that he ultimately will have to oversee a large debt write-down to resolve Argentina’s debt crisis. Elsewhere, we expect that Brazil’s central bank to cut its policy rate by another 50bp, to 5.00%, given below-target inflation and the approval of pension reform bill there. But slower progress on the government’s reform agenda means that rates will be on hold next year in our view. In contrast, Colombia’s central bank is likely to leave its policy rate at 4.25%. However, we think that downward pressure on the peso stemming from a wide current account will push up inflation, meaning that the next move in interest rates is more likely to be up than down. Finally, we think that Mexico’s GDP picked up to 0.5% q/q in Q3.

In Sub-Saharan Africa, we estimate that Kenya’s inflation picked up to 4.9 y/y in October, from 3.8% y/y in September. In South Africa, we think that the finance minister will announce forecasts for larger fiscal deficits in 2019/20 and 2020/21. We expect shortfalls of 6.5% of GDP this year and 5.5% next year. (Gareth Leather, Liam Peach, Nikhil Sanghani, Quinn Markwith & John Ashbourne)

Published at 15.51 BST 25th October 2019.

Editor: John Higgins (+44 20 7811 3912)
john.higgins@capitaleconomics.com
Enquiries: Olivia Cross (+44 20 7808 4089)
olivia.cross@capitaleconomics.com