Latin American populism fears overdone as stocks play catch-up

[dropcap]T[/dropcap]he world economy is enjoying a synchronised advance, and markets are enjoying the ride. But one region is missing out: Latin America.

This could be a pivotal year for the entire region. Brazil, Mexico, Colombia, Costa Rica and Paraguay all have elections for head of state this year, as does Venezuela (although there has to be some doubt over whether that one will take place). Even Cuba will have a new head of state, whose surname will not be Castro.

This could be significant as foreign investors have a long and undistinguished history of over-reacting to Latin American political developments. The arrival of a populist autocrat in power often leads to a collapse in confidence (and the sad history of Venezuela over the past 20 years shows why that might be).

Most of the time, however, angry-sounding populists tend to behave more sensibly once they are in power. The most spectacular example by far was the rally for Brazil after Luiz Inácio Lula da Silva (Lula) was first elected in late 2002. Treated in advance as an Armageddon scenario, it turned out that Lula was pragmatic in power, while the commodities boom took shares in Brazil to the moon. From November of 2002, when Lula wrapped up the presidency, to December 2007, the MSCI Brazil index gained more than 1,000 per cent. This was triple the rise in the emerging markets as a whole.

What are the chances that the continent’s continuing love-hate relationship with populist caudillos creates a buying opportunity like that this year?

It cannot be ruled out, although something as dramatic as the Lula rally of 2002 is hard to imagine. Latin America is not compellingly cheap at present, trading at a trailing price/earnings multiple of 17.7, according to MSCI. The p/e for emerging markets as a whole is 15.1. Brazil is through the worst of the horrendous political mess that saw the impeachment of former president Dilma Rousseff and has started an economic recovery, but this has been greeted over-exuberantly in markets. Buying in early 2016 would have led to a profit of 160 per cent by now.

Countries south of the Panama Canal are almost all exposed to China, so continued growth there will help perceptions of Brazil and the Andean economies, and another slowdown would be harmful. Mexico remains acutely exposed, in more ways than one, to the US — particularly at present to the risk that the US could decide to withdraw from Nafta, the free-trade agreement. Moves in the biggest building blocks of the world economy could drown out any political excitement in the region itself.

But the region is still palpably missing out on the excitement elsewhere. Since the election of Enrique Peña Nieto in Mexico in July 2012 ignited the last wave of optimism, Mexico and Brazil are down 11 and 14 per cent respectively, while emerging markets are up 32 per cent.

There is room for them to move forward a long way in a hurry, and room for plenty of confusion and volatility in the coming months as the two most important elections are impossible to call at this point. Mexico has a single-round election, so presidents can and do win election with less than half of the electorate. The frontrunner is Amlo — Andrés Manuel López Obrador, twice narrowly defeated before, a former mayor of Mexico City and the champion of the left. He is charismatic and messianic, and a victory for him would alarm the markets.

He is up against the unpopular incumbent and formerly hegemonic PRI party, which has an experienced technocrat in the race, José Antonio Meade, while in a weird development forced by the electoral system, the traditional parties of right and left have jointly nominated the 38-year-old Ricardo Anaya Cortés. All three candidates are capable of winning a third of the vote, and therefore all three might win.

Mexico has been a model of fiscal and monetary probity since its last major financial crisis in 1994, so an Amlo victory could scare the markets. However, he does have a track record in government, having been the mayor of Mexico City for six years, and showed himself to be competent and pragmatic in the job; and the situation he now faces looks very similar to 2006, when he appeared to be a long way ahead and eventually lost narrowly after he made the election about him. He may well not win, but if he does he would not be as frightening as many assume.

Meanwhile, Brazil’s election is wide open as its corruption scandal has claimed the scalps of many potential candidates. The frontrunners are Lula himself, providing he can quash a prison conviction for corruption, and Jair Bolsonaro, who has risen to the top of the polls with aggressive hard-right rhetoric. This is not healthy. But again, the chances look decent that Brazil will emerge with a viable president, with some kind of a mandate to act (thanks to the two-round system), which has been almost wholly lacking for the last four years of political turmoil.

World markets are producing lots of excitement but few bargains at present. For those with a strong constitution and a preparedness to be opportunistic, a dramatic year in Latin American politics might well offer this year’s closest approach to a bargain.