Alphacast Highlight - As Global risk is mode-on, Brazil saves Latam earnings in 2022
By Mariano Sanchez Moreno (msanchez@alphacast.io)
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in 2022, Brazil equity (EWZ, +21.9% YTD) has outperformed Latam (ILF, +15% YTD ) by 690 bps, driven by the market's favorable response to the recent presidential elections (+10.5% after elections). Its high Energy and Materials sector weighting allowed it to capture the gains of the commodity price rally during Q1-22 (DBC +22.3% QoQ), its long position in Financials is key in a rising interest rate environment. In hindsight, EWZ is at Aug-2016 values (post-Dilma Rousseff impeachment), but still trades 34.4% below its pre-pandemic peak.
Also, Selling pressures from global fixed income markets (BNDX -12.7%, AGG -14.2%, EMB -23.8% YTD) are being more benevolent on Brazilian bonds (EMBI Brazil JPM Total Return Index -7.5% YTD). Its bond yields validate the timing (it was the first to raise rates in the region) and aggressiveness (PM rate at 13.75%, +1175bps since Mar-21) of its central bank, which has led to a slowdown in inflation (headline inflation Jul-22 -0.7% and Aug-22 -0.40% MoM). In late Sep-22, its risk premium trades at 308bps (-223bps vs Latam), +16bps vs the 2-year average, and -758 bps below the peak of Mar-20, during the initial stages of the pandemic.
The main event that will shape the equity market in the short term is the presidential elections. Last October 2, the elections resulted in the left-wing candidate Lula da Silva as the winner, but the better-than-expected election of the current president Jair Bolsonaro forced a run-off election.
Undoubtedly the most outstanding feature of the Chilean capital market is the smoothness of its risk premium, which closed in September at 213bps (-318bps vs Latam), just +50bps above its historical average. In the last 15 years, the EMBI+Chile exceeded 300bps only twice (subprime crisis in Oct-08 and Covid-19 in Mar-20). The stability of its risk perception has been positively incorporated into its bond yields. More sensitive to changes in its central bank's monetary policy cycles than to political issues, the EMBI Chile JPM Total Return Index maintained an uptrend from Sep-13 to Dec-21. Fully in line with global and regional bond markets, Chilean fixed income trades -21% YTD, impacted by the aggressive tightening of its MP rate (10.75%, +9.25% since Sep-21).
Regarding stocks, Chile’s equity ETF accumulated positive performance as of late September (ECH, +15.6% YTD). Although it is usually traded with a high correlation to Latam (ILF, +15% YTD), the Chilean ETF is 24% exposed to Sociedad Química y Minera de Chile (SQM, +86.7% YTD), the world's largest lithium producer. Because of the lithium bull run, ECH’s returns are influenced by the outstanding performance of the company. As of September 30, the ECH was trading at USD 25.7 (+60% from the Mar-20 low), while in the last 18 months the index has traded sideways in the USD 22-29 range.
Up to late September, Mexico equities are performing poorly (EWW, -7.7% YTD) relative to their peers (ILF, +15% YTD). Due to the high weighting of Consumer Staples, EWW takes a hit from the impact of the current slowdown in consumption (Private Consumption Index +2.7% YTD, +3.1% since Feb-20) coupled with ex-post negative real wage changes since Apr-21 (Jun-22 -2.8%, Jul-22 -2.4% and Aug-22 -2.9% YoY). The Mexico equity ETF trades below both its two-year average (-4.70%) and pre-pandemic prices (-1.9%).
Although Banco de Mexico's rate hike has been the highest since the subprime crisis, hesitations to undertake both aggressive monetary tightening (PM rate rose from 4% in Jun-21 to 5.5% in Jan-22) and early (four months later than Brazil, for example) have resulted in an inflationary acceleration (Jun-22 8%, Jul-22 8.15% and Aug-22 8.7% YoY) not seen since Dec-00. That said, **by the end of September Mexico’s risk perception (490bps, +142 bps YTD) has correlated better with Latam (+150bps) than with Chile (+60 bps YTD) or Brazil (+3 bps YTD) and trades +107bps relative to its two-year average.
In this environment of higher risk, inflation, so-far-marginal rate hikes plus a world in risk-off mode, Mexico's bonds respond with a severe performance as of 2022 (EMBI Mexico JPM Total Return Index, -18.1% YTD), trading at Mar-19 prices and just +8.3% from the apb-20 pandemic low.
Peru's country risk closed September at 286bps (-244bps vs. Latam). Although throughout the last decade Peruvian risk perception has been more aligned with Chile than with the region, the violent social demonstrations in favor and against leftist president Pedro Castillo (since March 22 onwards) have caused strong volatility in the EMBI+Peru. With a high spread with respect to its two-year average (+100bps), the Peruvian risk premium is trading at similar values to the peak related to covid-19 (305 bps in Apr-20). Peru's fixed income, the least impacted by covid-19 in the region (-7.1% between Feb-20 and Apr-20, vs -12.1% for Colombia or -21.8% for Mexico), incorporates in its yields this negative outlook for 2022 (EMBI Peru JPM Total Return Index, -19.6% YTD). As of Sep-22, it is trading at Dec-18 prices and -20.3% vs. Feb-20.
Like its fixed income, Peruvian equity is not immune to the political turmoil the country is going through (EPU, -9.3% YTD). Over the last 5 years, EPU movements moved in line with Latam until Mar-22, where divergence is explained, in addition to the political driver, by the poor performance of copper (-20.5% YTD) since more than half of EPU is exposed to Materials and a fifth directly linked to this metal. As of Sep 30, EPU was trading at USD 25.9 (+18.8% from Mar-20 floor), below USD 30.7, the average of the last 18 months.
Argentina plays a separate game from the region, where local political ups and downs have been the background drivers. In early Jan-22, its central bank started an aggressive (+75% in Sep-22, +3700 bps YTD) but overdue interest rate tightening (Brazil started it in Mar-21), which seems to lag high inflation (+56.4% YTD). Argentina's capital market is going through a bear market that started in Jan-18, when fixed income hit record highs (EMBI Argentina JPM Total Return Index -69.4% since then). The massive sell-off that followed the presidential primaries in Aug-19 (-44% in the following two months) was even greater than the impact of the outbreak of the covid pandemic in Feb-20 (-35.3% in the following two months). With a debt restructuring with private creditors in Sep-20, an EFF program with the IMF for USD 44bn in Mar-22, a sell-off in inflation-linked mutual funds in Jun-22 plus high financial repression resulted in a low valuation of Argentine debt. That said, it is deepened by the impact of a globally appreciating dollar (DXY +16.4% YTD) and global rate hikes. By early October, risk perception (2708bps, +1020 bps YTD) is totally decoupled from the rest of the region (519bps, +138 bps YTD).
While keeping pace with the remarkable volatility of equities across Latam, Argentine equity (ARGT, +1.9% YTD) could not capitalize with the same magnitude on the regional tailwind during Q1 (ARGT +18.6%, Latam +33.3% and Brazil 42.3% QoQ). The adjustment in commodity prices during Q2 plus the local political factors described above made Argentina the most affected market (ARGT -28%, Latam -21.3% and Brazil -23% QoQ). As of early October, the ARGT trades +1.9% YTD, at Aug-19 primary presidential prices and +4.27% above the average of the last two years.
Noteworthy: Equity close price: October 4th
