Investors pour into Latin America – should you follow?

Latin America has been on fire this year, with Brazil looking looking particularly exciting. Yet there are signs of overheating - so investors should be prepared for a bumpy ride.

Latin America has been on fire this year, with the MSCI Latin America Index eclipsing emerging markets as a whole with a 50% rise in dollar terms. Brazil's Bovespa index has been the region's star performer, around 46% up on the year. Latin America is in good shape, says Urban Larson of F&C. Brazil and Mexico have paid down debt and "entrenched" low single-digit inflation.

And Brazil is the "most exciting country in the region", says Threadneedle's Katy Dobson. The trade deficit has moved into surplus, thanks to the commodities boom, while lower inflation has facilitated lower interest rates. Growth is set to pick up to at least 4.5% this year. Private consumption has become Brazil's "growth dynamo" as incomes have risen, says Merrill Lynch, which expects Brazilian earnings to rise by more than 30% in dollar terms this year, and pegs the market's forward p/e at around 13.

But there are signs of overheating. John Authers in the FT notes that the share price of iron-ore producer CVRD is up 91% since mid-August. Moreover, recent daily trading volumes have been almost four times higher than last year's average, and the Bovespa which last week become the first quoted stock exchange in Latin America is now worth more than the London Stock Exchange. Latin America now looks like a "geared play on global growth", says Authers.

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Investors have been flooding into emerging markets since the summer in the expectation that they would benefit from extra liquidity following Fed easing and would pick up the global-growth baton from the West. But the decoupling thesis remains unproven, while a near-term danger is increased risk aversion, thanks to renewed global credit jitters; in August, this wiped 19% off the Bovespa in dollar terms in a week. Latin America remains promising long-term, but investors look set for a bumpy ride.