By Stéphane Monier, Lombard Odier Group, Geneva
RIO DE JANEIRO, BRAZIL – Images of green oxygen cylinders have come to symbolize a collapsing health system in the Brazilian city of Manaus, in the northern state of Amazonas. Covid-19 patients in the city of 2 million people are dying during a second surge in cases as medical supplies run out. The pandemic management in Latin America highlights policy differences, with far-reaching implications for economic recoveries.
The economic impact of slow-to-implement vaccination programs, coupled with the risk of rising inflation, have created risks for investors in the region. In addition, the rest of the world is paying attention as the region tries to cope with a new Covid-19 variant.
Latin America as a whole has suffered the highest number of Covid cases worldwide as a share of population, with a mortality rate to match. One in ten Covid-related deaths globally is Brazilian. The country has recorded the second-highest number of Covid deaths after the US, with 224,504 fatalities as of February 1st and the third-highest number of infections, at 9.2 million. Mexico is third in the world in terms of Covid-related deaths at 158,536, with fewer than 2 million confirmed infections.
In Brazil, the vaccination programme’s start was politically charged. A state governor, rather than the federal government, drove a partnership with China’s Sinovac. As a result, Sāo Paulo state began vaccinations on 17 January, ahead of the nationally backed distribution of Oxford/AstraZeneca doses. The first vaccines were described by Sāo Paulo governor Joāo Doria as “the triumph of science and life against the denialists,” in remarks aimed at President Jair Bolsonaro. The president, who has described Covid-19 as “a little flu,” has said he will not be vaccinated.
As we publish, Brazil has vaccinated 1% of its population while Mexico has inoculated 0.5% of its people.
In Mexico, President Andrés Manuel López Obrador, known as AMLO, announced last week that he had tested positive for the virus. On December 24th, Mexico became the first Latin American nation to start a vaccination programme. The country is buying the AstraZeneca and Chinese CanSino vaccines as well as 24 million doses of the Russian-developed Sputnik V treatment.
Different fiscal choices
In terms of economic normalisation, high-frequency indicators show that Brazil and Mexico have recovered around 80-85% of pre-Covid activity levels.
At first glance, economic activity does not appear to vary greatly. However, the fiscal choices made by Brazil and Mexico have left the two economies with different reserves of financial firepower.
Brazil’s government stimulus, which was in line with many developed economies, has cushioned a -4.7% decline in 2020 GDP that looks healthy compared with some neighbors. The country chose to spend as much as 9.3% of GDP on support, including monthly cash handouts to its poorest populations. This helped Jair Bolsonaro to bolster his political position through 2020.
However, the government now finds itself breaching budget limits and government debt has risen to over 100% of GDP. Brazil’s December 2020 inflation has also exceeded the central bank’s 3.75% target for 2021. In a recent communication, Banco Central do Brasil hinted that it may raise the basic interest rate from the current level of 2.0%. This could undermine the 3.2% economic growth that experts currently expect for this year.
Mexican room for manoeuvre
In contrast, Mexico has spent relatively little on fiscal support. As a result, its economy suffered more through 2020, contracting -8.5% last year. The country’s budget deficit was below 3.5% of GDP in 2020, public debt as a share of GDP is expected to reach 54% in 2021. In addition, inflation falls within the central bank’s target range and leaves room to cut interest rates by 25 basis points to 4%.
Arguably, Mexico has room to spend more on its recovery in 2021, depending on political willingness. However, to date AMLO has opposed more public debt, rejecting calls from the IMF and World Bank.
Argentina’s challenges
Other economies in the region, such as Argentina, present a less-than compelling investment case. Argentina posted a GDP contraction of more than 11% in 2020. Its poor near-term economic growth outlook is exacerbated by Covid-19, high inflation and policy uncertainty. As a result, consumption, investment and exports all remain weak.
Government capital controls restricting access to dollars continue to exacerbate the gap between official exchange rates and the parallel market. Investors are still waiting for a credible policy aimed at generating fiscal stability as a precondition for economic growth. The International Monetary Fund will create further pressure for fiscal reform, although increasingly volatile politics may prove resistant, including opposition to spending cuts. Inflation is expected to have averaged 36% in 2020.
Selective emerging exposure
These diverse economic fortunes mean that from an asset allocation perspective, we remain highly selective. We are overweight in our total allocation to emerging market assets. However, this is largely due to our overweight positions in Asian investments, including China.
Latin America’s equity markets are dominated by financials, materials and energy stocks and account for more than 60% of the MSCI Brazil index by value. Hence, they are trading at relatively cheap 12-month valuations of 12.5 times earnings per share, which is in line with their 10-year average.
However, while this represents a sizeable discount to the rest of the world, in the short-term the outlook for LatAm stocks is challenging. Later in the year, once the economic recovery takes hold, the cyclical rotation will especially benefit companies active in commodities, such as Brazilian and Mexican oil, Brazil’s soybeans and Chilean copper.
Fixed income markets also demand a similarly careful investment approach. Sovereign debt in the region underperformed emerging markets in Asia, the Middle East and Eastern Europe in 2020. There is clearly more value in select high yield corporate debt, where, in contrast to government bonds, the region offered the highest credit returns.
This gap reflects fears of social instability with scheduled elections. Corporate credit, where many companies enjoy sound fundamentals, continues to offer opportunities for carry returns compared with the wider near-zero rate environment of sovereign debt and little prospect for spread tightening versus government bonds.
Through 2019 and 2020, we maintained a cautious view on the Brazilian real, due to the nation’s high debt levels. Instead, we favoured other currencies, including the Mexican peso and Chilean peso. Now, we expect Brazil’s real to only partly benefit from the broad emerging market rally against the US dollar. Markets have begun to price-in an interest rate rise and we remain cautious as we watch the uncertainties surrounding fiscal policy and vaccine distributions roll out.
On the other hand, while Mexico’s fundamentals are generally sound with positive real rates, we have recently turned more cautious; the peso screens as overvalued, and may suffer from uncertainties ahead of the country’s mid-term elections this year. Any interest rate cuts would also undermine investors’ carry returns.
Political tests ahead
As the region continues to struggle with the pandemic’s latest surge in infections, investors are also focused on a series of political tests in 2021. In July, mid-term elections will offer a referendum on AMLO’s leadership and chance to consolidate policy control. Argentina next holds a legislative election in October and Jair Bolsonaro does not face a Brazilian general election until October 2022. However, centrist parties in Brazil won a series of posts in December elections last year that may yet force a more conciliatory politics in Congress upon the country’s populist leader.
Lombard Odier Group
The Lombard Odier Group is an independent Swiss banking group based in Geneva. Its operations are organised into three divisions: private banking (wealth management), asset management, and back and middle office services for other financial institutions (e.g. banking IT). At the end of 2020, the bank reported outstanding balances managed through these three divisions totalling well over US$300 billion in managed assets, which makes it one of the biggest players in the Swiss private banking sector.
The group was formed in 2002, as Lombard, Odier, Darier, Hentsch & Cie, by the fusion of Lombard, Odier & Cie and Darier, Hentsch & Cie. As the latter was originally founded in 1796, the group has a claim to being the oldest private bank in Geneva. Outside of Switzerland, the bank has branches in the EU (centered in Luxembourg), in London, Moscow, in North America (New York, Boston, Montreal, Bermuda, Bahamas), Latin America (Panama, Uruguay), Asia (Hong Kong, Tokyo, Singapore, Dubai, Tel Aviv) and in South Africa. Including its network of collaborators, the group has around 2,400 employees worldwide.