Published On: Thu, Jan 3rd, 2019

Global uncertainty at Mexico and Brazil populist Presidents elected in 2018

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According to Yahoo Finance, the two largest Latin American economies, Mexico and Brazil, both elected populist Presidents in 2018 – and the new guard look set to impact stock markets this year. Right-wing conservative Jair Bolsonaro came to power in Brazil this week and the left-wing Andrés Manuel López Obrador, known as AMLO, was appointed last month in Mexico, but both are already causing waves.

As for most stock markets, 2018 was tough for Latin America, with MSCI Mexico underperforming the wider emerging market complex in US dollar terms losing 17.5% compared to the sector’s losses of 16.6%. In contrast, Brazil was down just 4%.

The changing political situation added volatility, and Mexico also faced the uncertainty surrounding negotiations with the US and Canada over the North American Free Trade Association (NAFTA).

But with both new Presidents now having taken up their positions and the NAFTA replacement, the US-Mexico-Canada Agreement (USMCA), agreed there should be fewer headwinds for the respective stock markets.

“Markets have been buoyed by a reduction in political uncertainty and strengthened hopes that key areas of reform will now be addressed,” say Will Lam and Ian Hargreaves, co-heads of Asian and emerging market equities at Invesco.

Still, investor attention will now turn to policies, where both Bolsonaro and AMLO prove divisive. The former, say analysts at Aviva, must navigate a fragmented Congress to deliver necessary fiscal reforms; the latter must walk a fine line between delivering on campaign promises and adhering to fiscal prudence.

Bullish on Brazil

The appointment of Chicago-trained economist as Brazil’s Finance Minister Paulo Guedes has been largely welcomed by markets. Pensions is one key area of reform he has already identified, with pension costs currently represent 55% of primary government spending. Tax cuts and simplifying the tax system is another area of focus.

Lam and Hargreaves both note these “would help reduce a large fiscal gap and go some way to restoring investor confidence and promoting consumption growth and investment spending”.

After a recession between 2014 and 2016, the pace of Brazil’s economic recovery since has been “sluggish”, the managers say. However, there’s cause for optimism here. Analysts at Bank of America Merrill Lynch expect the country’s post-election rally, which saw the Bovespa index jump 11% in the third quarter, to continue.

Growth for 2019 is predicted to come in at 3% by Aviva, while inflation is set to remain subdued as it moves modestly above 4% towards the end of the year. This will support an accommodative stance from the central bank, they add.

“The combination of easy financial conditions and an anticipated boost to confidence driven by a business-friendly administration will support consumption and investment.”

Sheridan Admans, investment manager at The Share Centre, says he continues to hold a positive long-term regional bias towards Brazilian equities. “With consumer sentiment in the region topping expectations, ongoing economic recovery and attractive valuations, the region continues to remain appealing,” he explains.

As ever with a new – and untested – political regime, risks are prevalent. Chinese investment and the re-negotiation of Mercosur, the South American trade agreement, are among those highlighted by Nicholas Hardingham, senior vice president of Franklin Templeton’s fixed income group.

But the biggest risk is the potential failure to pass fiscal reforms, particularly pension-related ones. The pension costs will continue to pressure debt ratios if left unchecked, say Aviva.

“The highly disjointed political environment makes Bolsonaro’s task more difficult, but an improved growth outlook and key political appointments should help generate enough political will to push through much needed reform,” they add.

Cautious on Mexico

New Mexican President AMLO was also initially considered a market-friendly candidate but concerns around that thesis have surfaced since his initial speech, says Hardingham.

Scrapping plans, via a referendum, to build a new airport in the capital, Mexico City, will not have gone down well with the business and investment communities. Meanwhile, Aviva harbours concerns around his “ambitious” spending plans.

These will “pressure inflation expectations and the currency and limit the central bank’s ability to ease policy, despite the current restrictive policy stance and with expectations for core inflation to fall towards 3%”, they say.




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