J.P. Morgan’s Pedro Martins Jr. holds the unique distinction of having guided two research departments to the top of the Latin America Research Team in the past four years. In 2010 he helped Bank of America Merrill Lynch make its first appearance in the winner’s circle in nearly a decade. That year, it shared the summit with J.P. Morgan, the firm where Martins began his career in 1994 after earning a bachelor’s degree in business administration at Fundação Getúlio Vargas — and the one to which he has since returned.
Martins has consistently published even as his responsibilities expanded to include oversight of research departments. He debuted on Institutional Investor’s Latin America Research Team in 2003 as leader of squads that finished second in Equity Strategy and third for coverage of Brazil. He has appeared every year since — even while moving from J.P. Morgan to BofA Merrill in 2005, then back again in 2012 — as the captain of crews that rank in one and often both of those sectors, earning a total of 22 appearances in the past 12 years. This year his squad rises one rung to claim second place in Equity Strategy.
Latin America is a market with many stories to tell. II Director of Research Thomas W. Johnson asked the São Paulo–based strategist to discuss the positives — and negatives — of investing in the region right now.
The International Monetary Fund believes that regional growth will remain sluggish through the rest of this year, with a slight improvement in 2015. Do you share this view?
Our real gross domestic product forecast for 2014 and 2015 indicates the region should grow below its potential, mainly due to Brazil’s low GDP forecast. Positive risks for investing include: one, fund flows to equities. Interest in LatAm equities is rising, and a large-scale rotation out of domestic savings and toward real assets could lead to valuation multiple expansions for equities. Two, acceleration of growth in developed markets. The U.S. housing market is getting better, and fiscal drag is easing. In Europe strong growth delta versus 2013, with peripheral spreads compressing, lower fiscal drag and improving financing conditions are all positive for global equities.
Negative risks include the phasing out of easy money. We see four consequences for LatAm equities: one, slower growth, weakening currencies and higher long rates; two, lower credit quality; three, liquidity consideration could be a headwind for small caps; and four, low-cost money might have created valuation excesses. Also, inflation remains elevated in Latin America. High inflation, notably lasting services inflation, restrains countries’ room to use countercyclical monetary policy. Potential weather disruptions due to El Niño could lead to continued increase in soft commodities prices.
What is your outlook for each of the region’s key markets?
We remain neutral on Mexico on unrealistic consensus earnings-per-share growth estimates. In our view, the current 14 percent estimate is too high considering economic dynamics, and thus is subject to downward revisions that would pressure already-high valuations. We are also neutral on Chile on: one, recent disappointing macro data and the strong downturn in local sentiment after the tax reform bill was sent to congress; two, negative impact on companies’ cash flow and earnings estimates — consensus yet elevated at 14.5 percent (in dollar terms) for 2014; three, the potential impact of the tax reform on the macro outlook for the country’s investment, unemployment and ultimately potential GDP growth.
The top-down view seems to be improving in Colombia. Activity is accelerating, and it seems that our 4.6 percent GDP growth estimate presents low downside risk. Despite an improving macro outlook, however, valuations are stretched and make it difficult to increase exposure to Colombia. The market is currently trading at 15.8 times 12-month forward price-earnings, a premium of 18 percent compared to history and 35 percent to LatAm.
We’ve reduced but reaffirmed our recommendation to underweight Brazil, to recognize a more competitive October 2014 presidential election. Our thesis has been anchored by two broad areas: one, equity market indicators — Brazil underperformance has not created extreme negative readings to foster a contrarian buying spirit among investors on positioning, valuation or earnings growth; and two, economic indicators. Brazil’s below-trend GDP growth, tighter monetary policy, forex devaluation risk and unconvincing fiscal performance continue to challenge the outlook valuation for multiple expansion.
Brazil remains beset with troubles, but its central bank has ruled out any further rate cuts, at least in the near term, and instead will focus on reining in inflation. Do you expect any meaningful economic developments ahead of the fall elections?
The outlook for Brazilian equities cannot be dissociated from the October 2014 presidential elections. In our view, the attitude of the incoming administration is more important than who wins. The next president will set the tone for re(de)-rating risk for equities by facing an intricate economic agenda, such as polishing macroeconomic pillars — fiscal discipline and inflation targeting — and the need for structural reforms to enhance competitiveness: simplify an onerous tax system, decrease expensive labor costs, and invest in infrastructure, to name a few priorities.
In recent months the central banks of Chile, Mexico and Peru have all lowered their benchmark rates in an effort to spur investment. Will this strategy work? Is there anything else policymakers should be doing to help stimulate growth?
A multiyear bull market for Latin American equities requires two different agendas at this point: one that is built on the pillars of inflation targeting, fiscal discipline, foreign exchange free floating and prices in the economy varying according to supply and demand; and one that would enhance cost competitiveness, requiring a protracted process of approving reforms at congress for complex issues such as flexible labor laws, reducing the cost of the state government — including social security — and tax reform.
Follow Thomas W. Johnson on Twitter at @tjohnson_NYC.
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