Latin America Surges Ahead: Why the Emerging Markets Underdog Outplayed most Others in 2023

We have seen rates around the world go from almost zero to considerable levels for the past two years, a time in which China has been disappointing at best. In this context, it was very hard to imagine that Latin American Equities would have outperformed S&P by over 40% and China by over 75% in the same period. So, what has happened?

Last year began with optimism over China’s reopening, but this was moderated over time, with activity figures failing to meet expectations. The Hang Seng fell -14% and commodities suffered from the Asian giant's weakness. Oil was unable to offset the slowdown in activity despite OPEC's announcement of various production cutbacks during the year, and it closed down 10%. In contrast, the S&P rose 24% thanks to the “Magnificent 7” and a significant slowdown in inflation, in line with reduced concerns regarding growth in the United States. It is interesting to note that an Equal weighted S&P yielded just 7%. For example, the financial sector returned 6%, compared to Latam’s 35%.

High inflation and resilient economic activity led the Fed to implement 4 benchmark rate hikes during the year, bringing it to the 5.25%-5.50% range. At the same time, its statements were hawkish, stressing that it would take some time before rate cuts began. This discourse began to change in November and became clear at the December FOMC, when the Fed recognized that its monetary policy was paying off, driving markets to project stronger cuts in 2024. In this context, the UST10y closed marginally above 3.88%, after peaking at 5.0% in June. Despite this, emerging market corporate debt performed strongly throughout the year, in the high single digits, led by Latam and Europe, with Asia somewhat weaker.

On the other hand, Latin America began its easing cycle, led by cutbacks of 200 and 300bps in Brazil and Chile, respectively. The region's central banks were able to start this process before the Fed because they increased rates more quickly to attack the inflationary problem, a trend that will continue in 2024. For their part, currencies appreciated strongly, led by the Colombian peso (+23%) and followed by the MXN and BRL, which rose 15% and 9%, respectively. This partially explains the divergence in the trend in different regions.

Things were also quite interesting at the country level. Mexico had peak levels of remittances that boosted consumption, capital investment and tourism, in addition to wage adjustments that contributed to consumption. All this is added to the main two processes that the country is going through, nearshoring and the pension reform, which are already significantly shifting the relevance foreign investment and AFOREs in the investment arena. Mexico consolidated its position as the top US trading partner in 2023, overtaking China and Canada.

Lula da Silva's new government in Brazil has surprised markets with its pragmatic approach. Finance Minister Haddad's market-friendly policies, including a new fiscal framework with spending cuts and debt reduction targets, have been met with applause. Petrobras and state-owned banks, adopting a conservative stance, have further boosted investor confidence. The proposed tax overhaul and efforts to tackle pension liabilities suggest a commitment to long-term fiscal sustainability. Fitch and S&P's upgrades to BB, the first since 2011, reflect this newfound prudence. GDP growth has surged, defying recession fears. The central bank's unwavering independence, exemplified by its recent interest rate decision despite political pressure, further bolsters Brazil's economic outlook. Under Lula's leadership, Brazil appears poised to shed its past image and emerge as a stable and prosperous nation.

In contrast, international rating agencies changed the outlook for Chile and Peru to negative, though they maintained their investment grade ratings. Chile once again rejected a new constitution, and the government has become much more pragmatic that originally thought. In Colombia, President Petro has been losing support, which is reflected in his inability to move forward with his proposed reforms in Congress and the poor performance by his party’s candidates in the regional elections.

One of the most media-intense elections of recent years was held in Argentina, where the libertarian candidate Javier Milei achieved a categorical victory after receiving 55.7% of the vote, reflecting the hope for a change of course in the country, which faces strong macroeconomic imbalances.

MSCI Latam returned 32.6% in 2023, reflecting in many ways this effect, which was helped by recovering earnings, a small but still present re rating in multiples and significant currency appreciation and dividends.

In terms of corporate news, we saw both positive and negative events, but the direction was quite interesting and significant things are happening within the region.

One major event shook the Brazilian retail landscape: Lojas Americanas, a leading retailer, was found to have hidden billions in debt by inflating supplier invoices. This fraudulent accounting, uncovered by a new CEO, cause the company to file for bankruptcy and dealt a severe blow to its reputation. In the aftermath, competitor Mercado Libre captured a significant portion of the market share lost by Americanas and is our top pick in the sector.

Brazil's utilities sector saw continued momentum in 2023 after the 2022 privatization of Eletrobras. The year kicked off with the privatization of Copel in Parana, and significant progress was made on privatizing water and sewage giant Sabesp in Sao Paulo. Notably, the country held its biggest transmission auction ever, attracting USD 21.8 billion in capex and awarding the largest lot to China's State Grid, marking a potential shift in foreign investment in the sector. This is something previously unthinkable under a Lula government.

Facing market headwinds like rising interest rates and investor withdrawals in 2023, the asset management industry held surprisingly steady with a total AUM of BRL 7.5 trillion backed by fixed income. BTG, in particular, thrived in this environment, increasing its AUM by 25% and outperforming competitors. This was the main overweight for a significant part of the year.

After a disrupting acquisition of proximity stores in Europe in 2022, Femsa, one of our main positions in Mexico, was heavily punished by investors due to its weak capital allocation strategy and blurry value proposition for stakeholders. After prolonged uncertainty, in 2023 it proposed the "Femsa forward plan," aimed at divesting itself of its stake in non-core assets such as US logistics, beer production and food chains in the United States. Since the plan’s implementation, Femsa management has been aiming for the best long-term value creation strategy, focusing on its core business: Retail and Beverages.

SQM, the world's second-largest lithium producer, and Codelco, Chile's state-owned copper giant, struck a historic deal just before New Year's Eve, reshaping the landscape of lithium mining. In a groundbreaking move, they agreed to jointly operate the Salar de Atacama, the world's most productive lithium mine, until 2060. This landmark partnership secures the mine's future while benefitting both parties.

Latin America surged onto the global investment scene in the past two years, shattering its underdog status. Democratic institutions have strengthened significantly, with corruption scandals declining by 40% over the past decade. Growth has returned to the region, fueled by tech innovation and rising disposable incomes. Commodities are at healthy levels as well, with not much new supply coming in the next few years. Local political execution and macro imbalances in China and the United States will continue to pose risks, but unbalanced ones. This is no longer a "niche of the niche." Latin America has become a vibrant investable universe with its own pace that demands a closer look. With healthy valuations and attractive potential, we believe this region presents a compelling investment opportunity worthy of global attention.