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Take it to the banco

Latin American markets have outperformed the more developed markets over the last year, driven by minimal sub-prime exposure, strength in commodities and strong domestic growth. Until recently, most markets were in positive territory for the year but recent concerns over commodities have seen a subsequent correction which has to attractive valuations.

Latin American economies have suffered the same inflationary pressures as the rest of the world but their reaction has been different. The US and UK responded slowly over worries of faltering economic growth but Latin American central banks have acted swiftly. Brazilian inflation was safely in line with the 4.5 per cent target until March when it suddenly spiked. Rates were very quickly raised by 175 basis points, leading to a fall in inflation expectations. Brazil is now in a strong position to lower interest rates in 2009, ahead of other countries, although it is likely to keep a tight rein on the situation for the foreseeable future. Colombia, Mexico and Peru have also moved to hike rates as inflation has risen.

Across the region, there has been very little sign of slowing credit growth and the tough stance adopted by central banks is reflected in the increasing strength of the financial sector.

Lending growth ranges from 25 to 35 per cent year on year across the region and mortgage lending in Brazil grew by 89 per cent in the first half of 2008. However, outstanding mortgages still account for less than 2 per cent of Brazilian GDP, lower than in the UK or the US.

We are very positive on the banking sector, particularly in Brazil through favoured positions in Banco Itau and Unibanco. This sector should continue to demonstrate solid balance sheets, high levels of profitability and strong lending growth from a low base. We are cautious on commodities, particularly materials where we remain underweight. In energy, we expect the global market to remain relatively tight but the biggest Latin American oil stock, Petrobras, should see production grow by 5 to 10 per cent a year for the next decade in a sector struggling to increase production. Brazilian oil services company Lupatech is a big beneficiary of Petrobras’s growth.

The outlook for homebuilding remains positive in Brazil and Mexico. Earnings for the first six months were quite strong and the sector is far less sensitive to changing interest rates, as mortgage lending is still in its infancy while the structural housing deficit is massive. Favoured positions include MRV (Brazil) and Urbi (Mexico).

Infrastructure stocks in Brazil and Mexico benefit from multi-year investment plans. We hold ICA, Mexico’s leading construction company which has won a number of bidding processes recently. We like Brazilian railroad operator All which has bought privatised railroad concessions and has made significant operational improvements while transporting increasing volumes of soy and other agricultural commodities.

Brazil’s utilities sector is the beneficiary of a tight electricity market and we hold Cemig which invests in big and small hydro plants, as well as electricity generation from biomass and wind.

The outlook for smaller markets is less positive but we can still identify attractive stocks. We like Argentina’s Tenaris which is the world leading producer of seamless steel tubes for the oil industry.

In Chile, we are concerned about the weakening economy and pension funds increasing their investments outside the country but we own electricity generator Endesa. The Colombian economy is slowing but we hold a position in Bancolombia. We believe capital controls in Colombia are likely to be lifted which will make it more attractive to equity investors.

Mexico has been the best performing Latin American market in the year to date but the economy is slowing, driven by US exposure, and we feel there is potential for disappointment in corporate earnings.

Urban Larson manages the F&C Latin American equity fund


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