Protest in Peru, Nov. 15, 2020. Photo by Flickr user Ennoti.
Long-term investing means realizing that short-term noise is often a distraction best ignored. But it also means understanding today’s reality when it comes to businesses and countries alike.
One of the basic tenets of long-term investing is that asset classes broadly revert to the mean over time. What goes down must come up, given a long enough time horizon. Cycles are normal. Even the effects of a pandemic or another major disruption will eventually even out. This is why the maxim “buy when there’s blood in the streets” has some truth to it. No downturn has been so bad that the market as a whole did not recover sooner or later.
However, there is a major point investors need to bear in mind: This observation applies to asset classes as a whole. It doesn’t apply to individual companies. A company’s stock can go to zero and never regain value. It also does not apply to individual countries. Investors with exposure to certain countries or regions should think carefully about the risk they are taking by staying invested.
In the past few years, many Latin American countries have faced major challenges. From their leaders’ actions, it is not clear to me whether they are learning the right lessons, either.
My colleague Larry Elkin has written in this space before about the steep decline of Venezuela. Since then, the situation has not improved in the country that was once Latin America’s richest. After the U.S. imposed sanctions in 2019, oil exports plummeted. Juan Guaido, who many countries (including the U.S.) recognize as the legitimate head of state, faces the end of his term as the speaker of Parliament in January, potentially leaving the opposition to President Nicolas Maduro without a leader. Venezuelans continue to endure hyperinflation and shortages of food, medicine and other staples. Millions have fled. Maduro’s authoritarian government, however, retains the support of countries including China and Russia, making the prospects for change in the short term complicated at best.
Even if Venezuela arguably remains Latin America’s basket case, it is not alone in facing rocky economic and political prospects. In Bolivia, the socialist party returned to power this month, allowing former president – and close Maduro ally – Evo Morales to return from his exile in Argentina. New president Luis Arce promptly moved to reestablish diplomatic relations with Venezuela and Iran. Arce must find a way to govern a deeply divided population. Meanwhile, Bolivia faces the rise of a new, Ebola-like virus after the COVID-19 pandemic has already delivered a major blow to its economy.
Argentina, meanwhile, had struggled with recession and stagflation for nearly a decade before COVID-19 hit. The potential of currency devaluation has many Argentines scrambling to convert pesos into luxury goods or other stores of value. As confidence has fallen, the gap between the official peso-dollar exchange rate and the peso’s black market value has ballooned. Argentina also faces a potential 12% contraction in gross domestic product this year, largely due to the pandemic. Meanwhile, the country continues to negotiate with the International Monetary Fund over the repayment of a $44 billion loan, but a group of senators recently went rogue and sent a letter threatening to scuttle negotiations if the IMF imposes conditions on a new repayment program. This move undercut gestures toward compromise from President Alberto Fernandez.
In Peru, last week brought a major constitutional crisis, in which the country recognized three presidents in a little more than a week. The country’s lawmakers voted to remove ex-President Martin Vizcarra, triggering major protests. The interim leader resigned after five days, leaving Peru without a president for more than a day. Francisco Sagasti, briefly the leader of Peru’s Congress, was next in line in the absence of a vice president. Sagasti faces continued protests and a skeptical population. Their skepticism is warranted; every living former Peruvian president is being investigated or has been charged with corruption, The Associated Press recently reported. And while Peru’s economy has been strong by regional standards, it too faces a major GDP contraction due to the pandemic.
Brazil, whose GDP dwarfs other South American countries, has faced its own problems in recent years. Petrobras, the state oil company, was the focus of a major graft scandal a few years ago. While it survived, it is currently in the process of major divestment in an effort to pay down outstanding debt. Its market capitalization has fallen from its peak of over $260 billion to below $60 billion today. The scandal sent shockwaves through Brazil’s government, leading to the impeachment of then-President Dilma Rousseff. The current president, Jair Bolsonaro, has vocally opposed masks and social distancing measures during the pandemic, even as Brazil’s economy has entered a tailspin. Bolsonaro also faces the potential of trade barriers with the United States. President-elect Joe Biden has indicated his willingness to impose economic consequences if Brazil doesn’t curtail deforestation in the Amazon.
Mexico – technically part of Latin America, though not all regional investment funds include it – was enduring a recession of its own before the pandemic. Despite some hopeful signs recently, it still faces a rocky economic outlook. President Andres Manuel Lopez Obrador, among the few world leaders yet to congratulate Biden on his victory at this writing, demanded that Gen. Salvador Cienfuegos Zepeda be returned to Mexico rather than facing drug trafficking charges in the United States. Critics have said that this action supports the perception that the president, popularly known as AMLO, puts the armed forces outside the law in his country.
In the past, Palisades Hudson Asset Management recommended that diversified client portfolios include Latin America-focused investments. Our original thesis was that Latin America offered two clear advantages: good demographics and healthy access to natural resources. In the years since, birth rates have dropped substantially in countries including Brazil, Mexico and others. And countries including Venezuela and Brazil have mismanaged natural resources or destroyed trust in management organizations through corruption scandals.
Political figures from Rahm Emanuel to Winston Churchill have been credited with the observation that you should never let a crisis go to waste. In 2020, Palisades Hudson’s investment committee agreed to liquidate all Latin America-focused mutual funds in client portfolios and invest the proceeds into other asset classes that have underperformed recently. While selling low is never appealing, we agreed that Latin America was reaching a point where reversion to the mean may never happen. With other diversified asset classes presenting attractive opportunities of their own, we agreed to take action.
All this is not to say that investors must avoid Latin American stocks in their portfolio at all costs. If a diversified international or global mutual fund or exchange-traded fund happens to include some exposure to a Latin American country, investors do not necessarily need to drop it. But if you have Latin America-focused funds or stocks in your portfolio, or if you are considering investing in them, it is important to be aware of the risks involved. In general, investors who take on higher risks expect the possibility of higher returns in exchange. For many of these countries, we believe the risks are too great for the level of returns we anticipate in the future.
Latin America is not a monolith. Doubtless some of these countries will achieve a brighter future than others. Some will successfully reverse worrying economic trends. But on the whole, investors outside the region have plenty of incentive to proceed with care.