Emerging markets rose over the second half of 2023, closing out the first calendar year of positive performance for the index since 2020. This year, we expect positive momentum for the asset class supported by falling interest rates and easing inflationary pressures – a trend that has been particularly pronounced in Latin America.
With inflation easing and interest rates coming down, most notably in Brazil, we expect a positive tailwind for consumers and corporates in the region over the next year.
A strong macroeconomic backdrop in Brazil
Having brought inflation under control following a proactive approach to raising interest rates, Brazil started cutting interest rates last summer – well ahead of the rest of the world. We think this cutting cycle will continue and accelerate when the Fed also starts to cut interest rates. This activity should be a huge boost to the consumer and corporates, who have both been under pressure due to higher borrowing costs.
Commodity prices also remain buoyant, while terms of trade are very attractive, resulting in a so-called ‘perfect storm’ of macroeconomic momentum for Brazil.
We currently see a lot of long-term investment opportunities in the country, supported by our recent research trip where we were able to scope out and gain conviction in several companies.
One stock that we have conviction in is Nu Holdings, a digital challenger bank that is rapidly growing its customer base and taking market share from incumbents.
Another more recent investment for us is Brazil-focused copper producer Ero Copper. We anticipate that the company should see free cash flow generation improve and is trading on attractive valuations. It should also benefit from a positive medium-to-long term outlook for copper, given that the commodity is integral to fulfilling the energy transition.
And finally, another financial services company we believe is exposed to positive demand drivers is the Brazilian bank, BTG Pactual. We expect the bank to benefit from falling interest rates as easier monetary policy drives more deals for its investment banking division.
Mexico benefits from positive structural drivers
Mexico also has a favourable macroeconomic backdrop. The country will benefit from the nascent trend of nearshoring as the US looks to shift its supply chains closer to its own borders.
Manufacturing labour is cheaper in Mexico than in coastal China and increasingly companies located in the US are looking to shift manufacturing closer to home.
There are numerous ways to gain exposure to this trend, including through logistics companies transporting manufactured goods to North America, or cement companies involved in construction. Our core holdings include cement producer GCC, and railroad operator Grupo Mexico Transportes.
Mexico, like many other countries across the globe, will host elections this year. Ruling party candidate, Claudia Sheinbaum, is currently leading the polls. Although her election could mean more fiscal pressures, it could also result in a more balanced congress, limiting the ruling party’s ability to make constitutional changes, and reducing the risk of policy intervention for companies – bolstering our already positive view on the country.
Opportunities for the short book
One key aspect of our investment strategy is the ability to short companies. In a higher interest-rate environment, this has the potential to offer a particularly good source of returns, as the unsustainable debt levels of many companies come into focus, and they pay the price of carrying too much leverage.
While Latin America offers many attractive opportunities for taking out long positions in stocks, in an environment where there are clear winners, there will inevitably be losers.
Short positions held in Latin American companies include a retailer that is losing share to a key competitor and a developed market listed silver miner with operations in Latin America that has suffered from elevated costs and declining production levels.
A go-anywhere approach
Although corporates globally have faced headwinds from higher interest rates, we continue to see broad balance-sheet strength in emerging market companies, and an improving macroeconomic backdrop across economies such as Brazil and Mexico.
With falling interest rates set to create positive momentum for companies and consumers, this should contribute to a shift in investors’ mindsets as they retreat from safe-haven assets and start to consider the value on offer in emerging market equities.
The extent of the derating within emerging markets over the past few years means that there are many high-quality names trading at very attractive valuations. Our team’s focus is on scouring the entire breadth of the market cap spectrum for ideas, taking a truly ‘go anywhere’ approach to ensure we are capturing a diverse set of businesses.
Chris Tennant is co-portfolio manager of Fidelity Emerging Markets Limited. The views expressed above should not be taken as investment advice.