BlackRock Latin American (BRLA) released its annual results to 31 December 2020, with the NAV returning -14.5% on a total return basis. Brazil comprises over 60% of the fund’s assets and like most of the region, it has been severely affected by the pandemic.
BRLA says the region was hit hard by the severity of the pandemic due to poor healthcare infrastructure and the significant fiscal deficits in many countries which reduced their ability to increase spending to ameliorate some of the worst of the economic effects. As was the case elsewhere, stock markets recovered in the second half of the year aided by the significant fiscal and monetary response from governments around the world which raised expectations of global economic growth and the development of effective vaccines to combat the pandemic.
BRLA noted that “Brazil and Colombia were the worst-performing equity markets in the region over the year. The Brazilian stock market fell by 19.0% as high levels of government debt reduced the authorities’ scope for making the very large stimulus measures taken in the developed world. Colombian markets were also down by 19.0% over the year; the impact of the pandemic was exacerbated by falling oil prices which drove up the country’s fiscal deficit. Markets in Mexico and Chile fared better and were relative outperformers, falling by just 1.9% and 5.6% respectively over the period.”
Not holding the e-commerce company Magazine Luiza weighed
At the stock level, BRLA’s off-benchmark position in Ternium, the leading steel company in Latin America, was the top contributor as the stock benefitted from rising steel prices in North America. The company has been investing in a significant new growth platform for Mexico and continues to emerge as a relative winner having taken share from weaker domestic competition in 2020. Elsewhere, an overweight in Via Varejo, a Brazilian retail company, also added to the portfolio on a relative basis, as the stock rose benefitting from the turnaround of the firm’s e-commerce platform under the new management and a relentless effort to carry on a digital transformation agenda.
The fact that BRLA did not hold Magazine Luiza, one of the largest Brazilian online retail companies, was the top detractor from relative returns as the stock rose in line with other online retailers, which benefitted from COVID-19 related lockdowns. An overweight position in Banco do Brasil weighed on relative performance during the period as the stock declined on the back of interest rate cuts and fears of increasing delinquency amongst borrowers as the Brazilian economy faced pressure from the global pandemic. From a sector perspective, the portfolio’s overweight stance in materials and healthcare were considerable contributors to performance during the year. Holdings in the Real Estate sector were notable detractors given weakened activity, rent holidays and increasing vacancy.
‘Forward earnings estimates in Brazil have been revised up considerably over the past 3 months’
In their outlook for 2021, BRLA’s managers, Sam Vecht and Ed Kuczma, said: “Key drivers for Latin American equities in 2021 will include the speed of global vaccine rollout, along with how individual countries are able to contain additional waves and variants of the virus. Since the end of last year we have started to see the market rotate and prepare for the re-opening of trade. Yet we are just starting to see pressure on re-opening as the inoculation process that started at the onset of 2021 may run short of vaccines with a blurry outlook for new supply amid diplomatic discussions and lack of coordination amongst distributing entities in many countries. In addition, we are starting to see states announce that the re-opening process initiated toward the end of the third quarter of 2020 is receding with the spike in the number of COVID-19 cases and rapidly increasing occupancy levels of ICUs. In our view, successful COVID-19 management matters for the continuation of the positive corporate earnings revision trend seen in the second half of 2020 and will help determine the direction of fiscal recovery in the region. While some countries in Latin America are ahead of other emerging nations in the vaccination programme, the numbers are likely to continue to be somewhat underwhelming in the early stages, especially if we compare them to developed markets. We are expecting a more meaningful percentage of the population in Latin America to be vaccinated in the second half of 2021 as new vaccines get approved.
Outside of COVID-19 related risk to recovery, the economic growth of China and the impact it will have on global commodity prices will continue to play an important role for investors in the region given Latin America’s abundance of natural resources. Furthermore, the current global environment of accommodative monetary and fiscal support provides a supportive backdrop for investors’ appetite for investing in Latin American equities. Finally, we continue to keep a close watch on political developments across the region as a number of critical issues were left unanswered in 2020 and we look forward to seeing how these events unfold in 2021.
With noticeable political changes in the United States we believe that President Biden’s fiscal policy and reforms will help to accelerate US GDP growth, providing positive tailwinds for the United States’ trading partners in Latin America, most notably Mexico. The success and pace of reform in Brazil remains an unanswered issue and we have become concerned with the lack of momentum on the reform agenda in 2020 given the understandable shift in focus for the country to deal with the impact that COVID-19 has had on Brazilian economy and society. Volatility in Brazilian markets has been on the rise in February and March as investors assess policy responses from the government related to fuel pricing and emergency aid connected to the COVID-19 pandemic. Policy credibility was questioned as February’s dismissal of the CEO of Petrobrás led to investor concerns that the hasty appointment of a new CEO might signal a potential shift away from market-friendly policies. In addition, the Senate is scheduled to vote on the emergency constitutional amendment related to government aid to individuals in March. This amendment aims to give legal support to a new round of cash transfers this year, in exchange for some medium-term adjustments to the fiscal accounts. Policy concerns escalated ahead of rumours that the additional government aid would also include proposals to further circumvent the budgetary spending cap which prompted a local market sell-off with the USD/BRL exchange rate reaching almost 5.80 at one point in early March.
However, events subsequently took a more positive turn as the government’s economic team managed to avoid including any measures to further circumvent the spending cap beyond the already-expected emergency aid. This relative improvement in the balance of risks immediately led to a market rally, as both the government and Congress chose a more credible fiscal option than that discussed ahead of voting on the amendment. The Senate then approved the emergency bill in a swift vote with more dilution of the proposed fiscal adjustment mechanisms, but limiting the emergency aid expenditure this year to BRL 44 billion (0.6% of GDP) and keeping additional cash transfer programme expenditure within the limits of the spending cap.
Following the market stress at the end of February, we believe that last week’s events were another reminder of how Brazil’s fiscal policy is on thin ice as the pandemic worsens and the spending cap becomes more binding amid a high level of debt. This policy instability is one reason we have been more cautious on Brazilian equities despite fourth-quarter results coming in stronger than expected. In addition, recent COVID-19 trends have been a headwind to near-term economic recovery as positive cases and hospitalizations have risen following the increased mobility and social gatherings surrounding the annual Carnival holiday.
In our view, the risk is that the rising pressures in the country (from the increase in policy uncertainty, the worsening of the COVID-19 pandemic, and the jump in input prices) all combine to have a significantly detrimental effect on the Brazilian economy. The government’s bias appears to be toward looser fiscal policy, although this pressure has been contained by the negative market reaction which has forced politicians to compromise on a more prudent fiscal solution. However, in the future we believe that there is a risk that the government may be put in a more difficult position as the 2022 general election approaches. In this tail-risk scenario, the country could face a protracted period of low growth and elevated inflation.
In Colombia, we see headwinds to the currency stemming from the potential downgrade of the country’s sovereign rating by global debt rating agencies. Colombia’s ability to avoid such actions will be dependent on the country’s execution in delivering a revenue positive tax reform and how the economy recovers from an extended pandemic and downturn without deep structural damage.
Peru faces an uncertain presidential election in April 2021 and despite being so close to the election, uncertainty remains elevated, as there is no clear leader in the race. The election outcome remains open as the latest polls show that more than a third of the population remains undecided. Moreover, the populist bias of the main candidates, as well as the fragmentation of the political system, could make uncertainty persist beyond the election. These factors could limit Peru’s capacity to benefit from a better external backdrop.
Looking ahead, we believe the earnings outlook for Latin America within the global context is robust and attractive, especially given the region’s large exposure to cyclical sectors such as financials, energy and materials that should benefit most as economies re-open. Illustrating this, earnings momentum in Latin America at the end of 2020 and early stages of 2021 has been firmly positive, led by Brazil where forward earnings estimates have been revised up considerably over the past 3 months. Yet in terms of valuations, Latin American markets trade at a meaningful discount to Emerging Markets and Asia. In addition, higher external growth from the US and China, buoyant commodity prices and ample liquidity from accommodative monetary and fiscal policy in developed markets are attractive tailwinds that make us optimistic on Latin American equities going forward.”
BRLA: BlackRock Latin American results reflect impact of the pandemic