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World Tour (Pt 4): South America Pinned to U.S., China Recovery

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July 28, 2015
Trading world tour: South America

Editor’s note: South America is the fourth stop in a seven-part tour of each continent’s economic and market outlook. Read our coverage of Europe and Asia, plus our North American focus on Canada.

The end of a commodities boom hit South America over the past two years, particularly powerhouse Brazil—a major exporter of agricultural and industrial commodities. Reversing South America’s fortunes sooner versus later will likely require a deeper U.S. and China recovery—and with it increased appetite for commodities, say analysts.

Political scandals in Brazil and Argentina, and even in relatively stable Chile, tarnished the image of the region for some investors. And oil-dependent Venezuela is suffering under the plunge in crude prices.

But for investors digging in for a long-run view of South America, it’s not all bad news. For instance, Colombia’s structural economy is rebuilding, although it too has felt the sting of a drop in oil and coal prices. Many companies in Brazil are restructuring their balance sheets, which may put them on better footing when it’s time for a recovery.

Young Population

Demographics work in South America’s favor. The average age there is 27.8 years, according to World Stat.

Kevin Carter, chairman of the EMQQ Index Committee and founder of Big Tree Capital (an investment manager focused on emerging and frontier markets), says having a younger demographic generally helps a country but it’s a short-term hindrance when the economy is struggling with unemployment.

Unemployment in Brazil is relatively low at 6.7%, but that level has risen throughout this year, according to Trading Economics. Similar trends are seen in Argentina, while unemployment is holding roughly steady in Chile and Colombia, Trading Economics data showed. 

Unemployment rates in Brazil

FIGURE 1: WRONG DIRECTION? The unemployment rate in Brazil increased to 6.7% in May 2015 from its record low of 4.3% in January. The rate averaged 8.39% from 2001 until 2015, reaching an all-time high of 13.1% in August 2003. Source: Trading Economics. For illustrative purposes only.

The commodities boom helped to create a consumer class that has new access to banking and credit lines, says Nick Robinson, head of Brazilian equities at Aberdeen Asset Management. But by 2013, fewer Brazilians became new consumers as the commodities boom subsided, and some of these new consumers took out too much debt, leaving them over-leveraged when the economic downturn came.

Bad Behavior

Additionally, corruption and political scandals have taken a toll on investor sentiment. For one, Brazil’s energy corporation Petrobras had to write off $2 billion after regulators uncovered massive bribes paid in a contract scandal; it occurred partly when Brazil's president, Dilma Rousseff, was Petrobras’ chair.

Argentina has had several political scandals, including the suspicious death of a special prosecutor who was due to testify against outgoing President Cristina Fernandez de Kirchner. Even Chile, which has been relatively immune to scandals, saw President Michelle Bachelet’s son accused of influence-peddling for land deals, among other corruption concerns.

Think Individuality

Right now investing in South America is a tough call, says Todd Millay, managing director, and Tamer Alamuddin, portfolio manager of Choate Investment Advisors. Investors need to look at the countries—and companies—individually and even then layer in extra caution, they say.

Many exporters were hit especially hard when slowing growth in China curbed its appetite for natural resources. According to the World Bank, China’s gross domestic product (GDP) grew by 7.4% in 2014—its slowest pace in 24 years. China’s GDP is forecast to fall to 7.1% this year and 7.0% next year.

That rise and fall for China is a particularly sensitive issue for Brazil, which is in a recession. By contrast, Colombia is more aligned with the U.S., which is on a recovery trajectory, Millay and Alamuddin said.

Patience Could Pay Off

Aberdeen’s Robinson sees signs of promise in the next 5 to 10 years. He said a number of Brazilian companies are shoring up their balance sheets to improve margins. That will take some time, but these firms could be in better shape when the economy recovers. He said investor research might extend to sectors tied to the domestic consumer, such as retailers and holding companies that own businesses including gas stations and shopping malls.

Longer-term, South America has growth potential, say some portfolio managers, but in the short term—say, the next one to two years—those managers are cautious. Sticking with equities means investors are less exposed to the nation’s sovereign debt, too.

Millay and Alamuddin suggest thinking big-picture with emerging market investing; South America could likely be a small percentage of a total emerging market investment. “Latin America will be a tactical decision for investors,” Alamuddin said. “Flows will come in when it is hot, and out when depressed. Asia, on the other hand, is a strategic call.”

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