Latin American Markets

We have been saying since the end of 2008 that Latin America, in general, will outperform more developed markets such as the U.S., Europe and Japan. Indeed it has been our mantra in the past few months. Currently, this view is becoming common sense.

According to the report released by the IMF this week, the Brazilian GDP should decline 1.3% this year. According to the same report, world economy is also expected to decrease 1.3%. The developed economies as a whole should decline 3.8%, with Japan the worst performer with a decrease of 6.2%. Among emerging economies, the worst case should be Russia with -6%; in Latin America the worst country would be Mexico with -3.7%. As expected, China will be the best performer with a growth of 6.5%. For 2010, Brazil is expected to grow 2.2%.

The market has already reacted to this understanding. Brazilian and Chinese equity markets have been outperforming the U.S. market by far, and we expect this trend to continue in the very short-term. Even commodity stocks, which are very cyclical, have been appreciating lately. This is more difficult to understand and explain.

Emerging economies will keep on leading the growth and developed economies, particularly the U.S., will rely a lot on government investments in infrastructure. It seems that the scenario is not bad for basic material producers -- it is undeniable that economic growth in the near future will be very commodity-intensive. However, we remain skeptical on commodity stocks -- or in other words, there are less risky and equally profitable (at least) alternatives in the Latin American domestic market.

Brazilian IGP (General Price Index) was -0.33% for the first 20 days of April against -0.36% for the same period in March. The IPA index (similar to the PPI) was -0.64% during the first 20 days of April from -0.65% in same period in March. It seems that inflation in Brazil is getting closer to the international deflationary trend. This is particularly important at this point because between June and August the annual harvest reaches the most important moment in Brazil, and agricultural prices have a seasonal tendency to decline in the beginning of the second half of the year.

In such an economic environment, what seems completely odd are the still unbelievably high Brazilian interest rates. After two cuts this year, Brazilian domestic rates still are at 11.25% per year. We believe Brazilian domestic rates will continue to fall in the very short-term, reaching somewhere in the 9% to 9.5% range in the end of 2009, despite the continued warnings of the Brazilian Central Bank over the so called "inflation risk." In fact, the Brazilian Central Bank is very orthodox -- it looks like a new version of the old Deutsche Bundesbank.

Since the Brazilian banking system remains healthy and solid, lower rates are not transformed into a liquidity trap. Amazingly, the total amount of consumer credit in Brazil already reached pre-crisis level. Despite the effect of the crisis in Latin America, which has been huge, we still believe that companies focused in local markets remains a great investment alternative for this difficult moment. Lower rates in Brazil will help to increase domestic consumption and counterbalance the effects of the crisis. Other Latin countries such as Chile and Peru are also well positioned to face the crisis.

OPPORTUNITIES

In such a business environment we would recommend some Brazilian domestic focused companies like the telecom companies Vivo (VIV - Snapshot Report) and Oi Participacoes (TNE - Analyst Report), consumption products producer like AmBev (ABV - Analyst Report), fuel retailers like Grupo Ultra (UGP - Analyst Report), high-dividend utilities like Telesp (TSP - Snapshot Report) and Cemig (CIG - Analyst Report). Outside Brazil we like Embotelladora Andina (AKO.A - Analyst Report) in Chile.
 
WEAKNESSES

On the other side, we would avoid highly levergaed raw material producers exposed to the U.S. market like Gerdau (GGB - Analyst Report) and Cemex SAB de CV (CX - Analyst Report).