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Brazil: Why Investors Should Be Cautious

With the Rio Olympics drawing the world's attention to Latin America, Aviva's Will Ballard looks at the investment prospects for the region

Emma Wall 10 August, 2016 | 12:01AM

 

 

Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Will Ballard, Head of Emerging Markets & Asia Pacific Equities for Aviva Investors.

Hi, Will.

Will Ballard: Hi.

Wall: So, I thought we'd start with Latin America. A lot of buzz about that region at the moment obviously with Rio Olympics happening at the moment. It's had quite a good run because of course commodities have rebounded this year after having quite a bad couple of years prior to that. How do you feel on the investment standpoint about the region?

Ballard: Yeah, you're exactly right. When you look at Brazil, certainly there's a lot of buzz. Everyone is focused on Rio, on the Olympics. People have been very focused on the lead up to the Olympics as well and looking at the state of the finances of the State of Rio de Janeiro as they try and finance the Olympics.

What you have to remember thought is that actually things in Brazil are still very tough. It's been a very tough environment. They've had the worst recession they've experienced for decades. Now, you have seen looser monetary policy coming out of developed markets; you've seen stimulus in China as well and that's made a big difference for their prospects.

So they are very tied into commodity exports and you can actually see that with an increase in demand from China commodities such as iron ore, steel, coal, et cetera, their prices have all picked up quite materially and Brazil has clearly been the beneficiary of that.

The one sort of note of caution I'd put there is that you've actually seen prices, certainly in the equity market, move quite materially already. So, valuations have picked up and yet, when you look at the underlying economy, well, actually the companies' earnings haven't really picked up yet. So, in fact, the market is starting to try and price in a bit of a recovery before the true signs are there.

Wall: And you mentioned China there, how inextricably linked these two are. China's demand is met by Brazil's commodities. Is China improving? Are there reasons to be positive about China again after a good year, I mean, the volatility last summer that took everyone off-guard? Is it time to get back into China?

Ballard: Well, I'd certainly put a note of caution when it comes to getting back into China. It really depends on how you do it and what you're investing in. When you look at China, what they did at the backend, well, after the slowdown in 2015 they put in a lot of stimulus, a lot more fixed asset investment and more credit growth. This is what some people would characterise as the old growth model of China, heavy fixed asset investment, lots of credit going into fuel that rather than the rebalancing which people are actually looking for.

So, in the short term, that's actually very positive. It's stabilized the economy. It created demand for countries, like Brazil, which we've talked about. But in the long term, are they actually dealing with the structural problems that they have with the low capacity utilization, with the excess supply in industries such as steel, coal, energy, et cetera? I would suggest they aren't yet and they actually need to get ahead with that.

Wall: And so there are reasons to be cautious about Brazil, there's reasons to be cautious about China. Where are you seeing those opportunities then for investment?

Ballard: When you look at emerging markets right now, there are opportunities, but you actually need to sort of delve down slightly deeper. You can't necessarily pick the biggest countries. So, we suggest you should look at some of the ASEAN countries, for example. Indonesia is a great example there.

So, what you've seen, if monetary policy from developed markets is looser for longer, if the U.S. doesn't tighten rates, if the U.S. dollar stays stable, which is what we've seen currently, and if China continues to grow at a reasonable rate, this gives Indonesia a great opportunity to lower rates, stimulate its domestic economy and bring back its own growth. Now, that could actually be a very good source of returns for equity investors.

Wall: Will, thank you very much.

Ballard: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk