Author: Christopher K. Baxter Investment Strategist, Wealth Management, Morgan Stanley
On the heels of a deep and long-lasting bear market, Latin American stocks may benefit from economic improvements and attractive valuations in 2023.
Inflation in Latin America peaked in June 2022, giving policymakers more runway to potentially begin slowing monetary tightening—a likely boon for the region’s stocks.
Latin American equities are trading cheaply, relative to both their own history and global peers, and could outperform emerging-market stocks broadly.
Brazil may benefit from expansion of trade with China. Mexico could see a surge in exports to the U.S. as businesses move supply chains closer to home.
Not long ago, emerging markets (EM) stocks were suffering their longest and one of their steepest bear markets on record. Buffeted by a surging U.S. dollar and uncertainty around China’s economy, the MSCI EM Index fell nearly 40% from its February 2021 peak to its October 2022 trough.
But as the dollar’s strength potentially peaks and China eases COVID restrictions, the EM outlook is brightening. In fact, Morgan Stanley Research sees a new EM equity bull market beginning—one that could endure for years in some regions and create attractive opportunities for investors during a period of potentially muted U.S. stock returns.
Still, emerging markets are not a monolith. There have long been relative winners and losers, so it’s important to be discerning in this asset class. Currently, a number of countries in Latin America stand to benefit from favorable trends in monetary policy, inflation and global trade that could create powerful momentum for stocks in 2023.
A Favorable Economic Backdrop
Latin America’s moderating inflation has been particularly notable; many of Latin America’s central bankers got an aggressive head start on monetary tightening during the pandemic. As a result, while price pressures in the U.S. only recently began to abate, inflation in Latin America peaked at 9.3% in June 2022 and has since fallen to 2021 levels, giving policymakers more runway to potentially begin slowing monetary tightening—a likely boon for Latin American stocks.
In addition, we believe the strong U.S. dollar may lose momentum as the Federal Reserve’s rate-hiking cycle matures and relative economic growth outside the U.S. improves, allowing EM economies to benefit.
Against this potentially more favorable backdrop, Latin American stocks deserve a closer look for a number of reasons:
They are coming off a period of remarkable resilience. During the latest EM bear market, the MSCI EM Latin America Index declined just over 5% through Jan 13, its smallest drawdown of any EM bear-market period going back to 1997. The region’s average decline during EM bear markets over that period was 41.7%.
They are currently trading cheaply, relative to both their own history and global peers. Latin America’s 12-month trailing price-earnings (P/E) ratio, at 7.0, is just off its lowest level since 2008 and compares favorably with both the broader MSCI EM Index’s average of 10.5 and the S&P 500 Index’s 18.9.
They are poised to outperform EM stocks broadly. In the past, when Latin American equities have traded more cheaply than the MSCI EM Index at bear-market troughs—as they recently did, by the widest margin in more than 20 years—the region’s stocks have gone on to beat the broader EM index by a median 20% to the next cycle peak.
Bright Spots in Brazil and Mexico
Particular opportunities stand out in two countries:
The headline consumer price index in Latin America’s largest country has fallen sharply, from a 27-year high of 12.1% in April 2022 to 5.8% in December. Meanwhile, the Brazilian government’s ambitious anti-poverty program is likely to support labor-market gains that could help strengthen economic growth.
What’s more, China’s economic reopening is likely to drive robust expansion in trade for Brazil, which counts the world’s second-largest economy as its biggest trading partner. These economic tailwinds could boost Brazilian equities, which currently trade at a deep discount. Watch for opportunities in commodities such as iron ore slag and ash, which are used to produce iron and steel and represent about one-third of Brazil’s exports to China.
A likely slowdown in U.S. travel to Mexico poses a near-term obstacle in a country where tourism represents 15% of GDP and 13% of all jobs and where 70% of international travel comes from the U.S. Languishing sales in the auto sector, which accounts for 20% of Mexico’s manufacturing output, may also weigh on growth.
Over the long term, however, we believe a “near-shoring” trend, which drives global businesses to move supply chains closer to home, could substantially boost U.S. investment in Mexico. In fact, Mexico could see a $155 billion surge in exports to the U.S.—or more than 10% of Mexico’s GDP—over a five-year period. The electronics, metals, auto and machinery sectors could be the greatest beneficiaries.
Currently, Latin American stocks are likely under-owned in global portfolios relative to their contribution to global equity market capitalization. In 2023, we think investors should reassesses their exposure to these opportunities, especially in Latin America, and with a close eye on Brazil and Mexico.
Connect with your Morgan Stanley Financial Advisor to request a copy of the Global Investment Office report, “The Emerging Question: Investing in Latin America,” and learn more about how your portfolio might benefit from exposure to these opportunities.