Emerging markets have been flattened by investors’ stampede for the exit. The Institute of International Finance estimates that overseas investors pulled $95bn from emerging markets in the first quarter of 2020 – a record quarterly outflow. Investors are right to be worried. Emerging markets tend to have poor health systems and cash-strapped governments, which make it harder to battle coronavirus. That’s especially true in Latin America, which seems the most vulnerable region. The International Monetary Fund (IMF) thinks Latin America’s economies will contract by 5.2% this year, worse than Africa or East Asia and as bad as eastern Europe.
But don’t be discouraged by those grim numbers. The sell-off has created an opportunity. Some Latin American countries – in particular the Andean Three of Colombia, Peru and Chile – look well placed to contain and recover from coronavirus. The pandemic won’t alter their strong medium-term growth prospects, but it has given us a chance to buy in at rock-bottom prices.
Lessons from Ecuador
The money managers and analysts were quick to react, but the virus took its time to travel west to Latin America and will wreak further havoc. I write this in the city of Guayaquil on Ecuador’s Pacific coast, the early epicentre of Covid-19 in the region. According to excess mortality data analysed by the Financial Times, during a fortnight spanning March and April the city had the world’s largest increase in extra deaths, with a 485% jump in fatalities from the historical average for that time of year. Unfortunately, the factors that exacerbated the crisis in Ecuador are commonplace across Latin America.
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One problem is weak health systems. In most Latin American countries expensive private clinics – offering decent care by international standards – operate alongside underfunded public hospitals. The rapid collapse of Guayaquil’s health services, where there was a shortage of hospital beds, drugs and medical oxygen, will be repeated in other countries. Corruption and inefficiency in public health bodies hardly help.
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Of course, these problems bedevil all emerging markets, but Latin America looks particularly susceptible. It has two of the world’s five largest cities, which will make social distancing difficult. Obesity, which early studies find a significant contributor to coronavirus cases needing critical care, is higher in Latin America than Africa, Asia or eastern Europe. And the IMF found more Latin Americans work in the informal sector than any other emerging market. That matters in a pandemic because it’s much harder to give informal workers the financial assistance they need to observe the quarantine.
The biggest lesson from Ecuador is that money matters. Ecuador’s economy was a mess before coronavirus arrived; it was struggling to maintain the terms of an IMF bailout. A lack of money hits countries in two ways. Firstly, it makes it harder to control the pandemic as there isn’t the cash to upgrade health systems, import equipment and give people the financial assistance needed to maintain lockdown. Secondly it exacerbates the economic impact, as in the absence of stimulus measures, more companies go bankrupt and more jobs are lost. That means that the eventual economic recovery will take longer.
Why the Andean Three will bounce back
So far, the article makes pretty grim reading, so congratulations if you got this far – your perseverance will be rewarded. Because although Latin America is in for a huge recession, there are some countries that will bounce back quickly. Chile, Peru and Colombia are long-term favourites of mine because they are well-managed, open economies, with positive demographics and great growth potential. They are also the best-placed major economies in Latin America to control and quickly recover from coronavirus.
The key factor with the Andean Three is that they entered the pandemic from a position of macroeconomic strength that allowed them to respond effectively. Peru’s combined fiscal and monetary package is worth 12% of GDP and is the region’s largest stimulus. The largesse is possible because its 2019 fiscal and current-account deficits were just 1.6% and 1.5% respectively, while its total debt-to-GDP ratio was only 26%. Its reserves comfortably cover external financing requirements, while it bolstered its position by securing an $18bn precautionary credit line with the IMF.
Chile also responded strongly, with a fiscal stimulus worth 6% of GDP, while its central bank launched the country’s first-ever quantitative easing (QE), or money printing programme, spending $4bn on bank bonds. Following political protests last year, Chile was already beefing up welfare payments and social services and the pandemic will merely accelerate that trend.
With a 2019 public debt-to-GDP ratio of just 28%, the country can afford to spend its way out of the crisis. Moreover, thanks to its strong institutions it is spending wisely. It has conducted more coronavirus tests than any other nation in the region, allowing it to implement a sophisticated partial-lockdown strategy.
Colombia’s situation is the most precarious of the three, but still positive compared with the rest of the region. Public debt-to-GDP stood at 51% in 2019, although growth reached 3.3% and the deficit just 2%. Moreover, the collapse in the oil price hit the country’s main export. These factors limited Colombia’s fiscal stimulus to 1.5%. However, the central bank was the first in Latin America to implement QE with a $3bn programme that covered private and public debt.
The three countries’ solid financial position entering the crisis allowed them to take strong measures to contain its economic impact and speed the future recovery. The IMF projects a fall in 2020 GDP of 2.4% for Colombia and 4.5% for both Chile and Peru in 2020, which is better than the regional average of -5.2%. (It has pencilled in a 6% contraction for the UK.) And crucially, all of the Andean Three will see a strong rebound in 2021. If the IMF is right in its estimate of 3.7% expansion in Colombia in 2021, 5.3% in Chile and 5.2% in Peru, then all three economies will be bigger at the end of next year than they are now.
A compelling structural growth story
The main reason to invest in the Andean Three is their growth prospects over the next decade. All three are commodity powerhouses. Chile has the world’s largest reserves of copper and lithium, while Peru has the most silver on the planet, third-most copper and fifth-most gold. Colombia has a more varied commodity export basket that includes iron ore and oil. Many countries boast plentiful raw materials, but these three are very well run: they survived the last decade’s commodity crunch without succumbing to recession.
They have also diversified significantly in the last decade, with non-traditional agricultural exports such as blueberries, avocados and grapes becoming the second or third-largest foreign-currency earner in Peru and Chile. Chile is the richest of the three, while Colombia and Peru have the best demographics, with young populations and expanding workforces. Covid-19 is wreaking havoc in the short-term, but over the coming decades the world will still need the food, energy and metals that these countries have in abundance.
If you accept that, then you should buy into the Andean Three now – they are going cheap. One of the best ways to see if a stockmarket is good value is the cyclically adjusted price/earnings (p/e) ratio (Cape). This compares the current market price with average earnings over the last decade, thereby smoothing out any impact from abnormal years. German asset manager StarCapital has just crunched the Latin American Cape numbers and Colombia is the cheapest on 10.1, while at 10.8 Chile is around half the level it was in late 2018. Peru’s 10.9 is down from almost 17 just six months ago.
What to buy
The easiest way to invest would be through exchange-traded funds (ETFs) for each country. Unfortunately, current regulations mean that UK retail investors can’t access the Peru, Chile or Colombia ETFs. However, a Latin American fund manager gave me a good tip to get around the situation: buy banks. If it’s a well-run bank in a prudently regulated financial system then it’s like buying an ETF, as it will have exposure to every sector of the economy.
So how safe is the financial system in the Andean Three? “Latin American banks are generally in good shape,” says Quinn Markwith, Latin America analyst at Capital Economics, a consultancy. “Stronger public finances mean Peru and Chile are better placed to support their banks than Brazil and Mexico.” His analysis of Latin America’s financial sector shows that “banks are in similar shape to how they were on the eve of the Great Financial Crisis” – which they all survived comfortably. They are well capitalised and non-performing loan ratios are generally low at 2%-4%.
So Latin America’s banks aren’t going bust. But their share prices have slid, which gives us some bargains. Peru’s largest financial institution, Credicorp (NYSE: BAP) has dropped by 42% since January. On a forward p/e ratio of nine it gives us a cheap way to play Peru’s recovery. In Colombia, consider Bancolombia (NYSE: CIB), which has fallen more than 50% since mid-February and trades on a forward p/e of eight. My Chilean pick is Banco de Chile (NYSE: BCH) on a trailing p/e of 9.6.
