Tags: Latin America, Mike Caggeso, Outlook 2008

Outlook 2008: The Latin American Economy is 'Muy Caliente' 

By , Money Morning •

Editor's Note: This is the 10th Installment of an Ongoing Series Highlighting the Global Investing Outlook for 2008.

By Mike Caggeso
Associate Editor

If  2007 proved one thing, it was that - next to China and India - Latin America is the world's next great emerging market.

The 19 countries in the Latin America-Caribbean region saw their Gross Domestic Product (GDP) advance at an average pace of 5.6% last year - marking the fifth-straight year of continued growth for a region historically known for its economic volatility.

Poverty in the region declined 35% in 2007, according to the United Nations Economic Commission for Latin America and the Caribbean (ECLAC). On top of that, unemployment fell by 8% last year.

And Latin America's rich commodity reserves and growing middle class drove a good portion of that growth. That's no small point, given that it proves the region is increasingly able to sustain itself, especially now that the turbulent U.S. credit crisis is hamstringing the American economy and thus threatening other countries' exports.

As it did in 2007, Latin America's projected growth for this year makes it a region where investors need to be.

Diverse Growth Across the Spectrum

A broad spectrum of political leaders - from Felipe Calderon of Mexico to Hugo Chavez of Venezuela - are operating within the boundaries of Latin America, and their economic policies often bump heads.

Furthermore, each region of Latin America has a different catalyst driving its economy: It's oil and natural gas for Venezuela and Bolivia, the service sector for Peru, copper for Chile [it accounts for nearly one-third of the world's supply], agriculture for Mexico, and so-called "soft commodities" for Argentina.

But the elephant in the room is Brazil, the largest economy in Latin America and the ninth largest in the world. And Brazil's economy is sizzling. According to the International Monetary Fund, real GDP growth clocked in at 4.5% in 2007, topping the 3.75% growth of 2006. And, as of May, the 12-month CPI inflation was 3.2%, well below the IMF's target of 4.5%.

Much like India - though on a smaller scale in terms of population - the economy of Brazil is driven by organic growth, thanks largely to that South American country's big industrial markets, its manufacturing base, and its wealth of soft commodities - sugar, corn, soybeans, wheat -which are all rising in value because of growing worldwide demand.

Seeing dollar signs, many have left Brazil's crowded coastline metropolises to grow these commodities.

"Brazil experienced urban migration for the past 20 years and that's starting to reverse because of the agricultural growth that's happening," Alexander Carpenter, vice president and senior credit officer for Moody's Latin America Ltd., told Money Morning.

Export growth has caused trade surpluses to balloon, and the government's tight fiscal policies have resulted in budget surpluses and declining public debt.

"Executive directors commended the authorities for the strong performance of Brazil's economy, which-against the backdrop of a favorable global environment-has been reaping the benefits of an impressive fiscal effort, sound monetary policy, and a reduction in vulnerabilities," the IMF said.

Brazil's all-around growth is fostering the expansion of a vast middle class that is, in turn, reinvesting its capital back into the country's massive service sector, and stock market.

Moody's Carpenter said more than 40 companies in Brazil went public in 2007.

What Will Move Latin America in 2008?

Money Morning Contributing Editor Horacio R. Marquez, an emerging-markets specialist and Argentine native, said Latin America's growth is contingent on three factors:

  1. The price of commodities/global growth: Continued growth in China, India and other emerging markets can only further stoke the already high demand for commodities. For example, China's consumption of iron ore is one of the top reasons why the share price of Brazilian mining company Vale (RIO), formerly Companhia Vale do Rio Doce, more than doubled last year.
  2. The "second wave" of profits: This refers to the countries' ability to keep driving their economies by increasing their internal consumer growth and demand.
  3. The health of the U.S. economy: If anything tugs at Latin America's growth, it's the region's economic ties with its trading partners, especially the United States. It wasn't a coincidence that when the U.S. greenback declined last year, the Brazilian real dropped in virtual lockstep. A wild card here is how the subprime fallout plays out in Europe, another key sales destination for South American exports.

Investors can dodge this potential trap by avoiding currency trades, as well as the shares of Latin American companies whose primary customer is the United States. Instead, investors should focus on Latin America's wealth of commodities [which are in demand in nearly every world market], and companies that profit from the region's growing middle class.

Profit Plays for the New Year

Let's look at each sector, as well as the potential profit plays:

  • Energy: Latin America's appetite for energy is nothing short of ravenous. As of now, three-fourths of the country's electricity comes from hydroelectric power. That figure will be higher in 2012, when the region's largest hydroelectric project, the Santo Antonio Dam, will begin producing electricity. Santo Antonio is the first of three Amazon River dams the government hopes will wane Brazil's need for fossil fuels. Until then, however, Brazil's state-controlled oil-and-gas company, Petroleo Brasilero SA (PBR), also known as Petrobras, will continue to meet the demand.
  • Food/Retail: As Latin America's population and middle class expand inland from its coastal metropolises, the food and retail sectors are some of the first to profit. One company that's been profiting from this population-and-development trend is the Companhia de Bebidas das Americas, also known as AmBev (ABV), a $45 billion Brazil-based beverage powerhouse that produces, sells and distributes beer, draft beer, malt, soft drinks, sport drinks, iced tea and water throughout Latin American and the Caribbean. Similar, though smaller, the Companhia Brasileira De Distribuicao (CBD) is a food retailer with more than 550 supermarkets, home appliance stores and convenience stores throughout Brazil.
  • Mining: South America is stuffed with metals. And with commodity prices soaring, this is a good market to be in. As mentioned earlier, Vale is making a killing feeding China's appetite for iron ore. It's the second-largest mining company in the world, and the largest producer of iron ore and nickel. The Phoenix, Ariz.-based mining giant Southern Copper Corp. (PCU) heavily taps South America's rich copper mines. Though based in the United States, this company has all of its mining, refining and smelting operations in Mexico and Peru. With this stock, however, investors are subject to the volatility of the U.S. markets, which don't look very promising in the first half of the year.
  • Banking/Real Estate: According to Money Morning's Marquez, "when the [Brazilian] economy expands, [banks] do fantastically well." And the same goes for real estate. Some of the first banks to profit from the growth of the middle class are Banco Bradesco SA (BBD), Uniao de Bancos Brasileiros SA (UBB) - also known as Unibanco - and Banco Itau Holding Financeira SA (ITU).  "Buy them and go to sleep," Money Morning's Marquez said.  But white-knuckle speculators may want to roll the dice on Gafisa SA (GFA), a homebuilder based in Sao Paulo, Brazil.
  • ETFs: Investors who are wary of investing directly in foreign companies have a few exchange-traded funds to choose from. The iShares Standard & Poor's Latin America 40 Index (ILF), which tracks highly liquid securities in Mexico, Brazil, Argentina and Chile, ended 2007 with a 44% gain.  There's also iShares MSCI Brazil Index Fund (EWZ), a capitalization-weighted index that aims to capture 85% of the total market capitalization in Brazil. It invests in a sample of securities and is reviewed quarterly. Last year, it gained a healthy 72%.

Editor's Note: Money Morning's "Outlook 2008" series last covered India. Next up: The U.S. Dollar.

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