Emerging Markets: LatAm’s land of opportunities shows no sign of slowing
Latin America faces elections in three of its largest economies this year, but bond market participants are feeling confident, after technicals helped 2017 to defy all expectations and with economic activity set to improve in 2018. Oliver West reports.
Bond market participants in Latin America have always been resilient folk, and last year it looked like they were in for another difficult ride.
The Fed and an unpredictable US president, combined with Brazil’s corruption scandals, Argentina’s urgent funding needs and Venezuela’s worsening crisis made potential risks easy to pinpoint.
The difficulties certainly arrived: Trump began Nafta renegotiations; Brazil’s president was accused of endorsing bribes; and some DCM bankers were barricaded in their hotel at the IADB meetings in Paraguay as protesters set fire to Congress. To add to the fun, Nicolás Maduro announced plans to restructure all Venezuelan external debt.
Latin lovers (of liquidity)
Yet for all the stress, the bond market hardly hit a dip. As developed market monetary policy drove the search for yield, EM inflows hit a record of about $110bn, and any political events only ever caused short-lived softening.
“Sell-offs have lasted only briefly because buyers have stepped in and immediately improved the tone, while technical conditions are very strong,” says Matthew Dukes, director in Latin American debt capital markets at Deutsche Bank in New York.
The effect on new issue volumes was astonishing. By November 20, there had already been $135.5bn of LatAm cross-border issuance, according to Dealogic — or more than $140bn, according to some banks. It was certainly already more than the previous full year record of $132bn set in 2014, and the $128bn posted in 2016.
“I don’t think anybody would have predicted that by November we would have already broken the all-time LatAm issuance volume record,” says Dukes. “Many of the themes that have supported the market we would expect to remain in place for the foreseeable future.”
Max Volkov, head of Latin America DCM at Bank of America Merrill Lynch, says LatAm bond markets will continue to “take their cue” from the US investment grade market. “If US IG spreads are anchored by technicals, EM will benefit,” he says.
Both Volkov and Dukes point to a surprise in inflation readings as the biggest risks to market conditions, because of the rates volatility that would probably follow. Volkov expects the Fed to become more of a factor in 2018, potentially causing more volatility, but LatAm could be a beneficiary for a while yet.
“Although market conditions softened towards the end of the year, I see this as a healthy correction,” says Volkov. “Come January, the market will reload and the first quarter will be very busy.”
This is not just bullish sell-side talk, either. “There continues to be a lot of demand for EM debt and equities, and while inflows from retail investors are strong, strategic investors are also putting money in,” says Jennifer Gorgoll, co-lead portfolio manager for EM corporates at Neuberger Berman in Atlanta. “People say these conditions can’t last, so you have to keep watching, but I think being fully invested and allocated is the way to be.”
LatAm bond market participants are therefore calm heading into what JP Morgan reckons is the region’s “heaviest political calendar in a dozen years”, with Colombia, Mexico and Brazil set to elect new presidents in 2018. The message for issuers is simple: take advantage while the going is good.
“Frequent issuers will need to remain nimble,” says Dukes. “Issuers will look to take advantage of the current environment and de-risk their funding needs as early as possible in 2018.”
Dukes foresees the possibility of a slowdown in issuance from countries holding elections, but adds that any spillover to other jurisdictions is likely to be very limited.
And Volkov says that it is “hard to see why volumes would be hugely different” this year, adding that the three largest markets of Argentina, Brazil and Mexico will post similar numbers.
His view is backed by JP Morgan, which predicts in its 2018 outlook that “moderate capex requirements going forward and upcoming maturities should keep new issuance levels in line with 2017” in Latin America.
If markets are expecting some volatility in anticipation of all three elections, it is Mexico where concern is greatest. Already suffering the uncertainty surrounding the future of Nafta, Andrés Manuel López Obrador, described by Capital Economics as a “left-wing firebrand”, was leading polls late last year.
For overall year-on-year volumes, this is not necessarily a setback; Mexico was already the clear weak link in terms of sources of deals last year, dropping from $41bn in 2016 to just $28bn in 2017 as of November 20, according to Dealogic.
“Mexican elections need to be watched, but Mexico was not a big driver of volumes last year,” points out Cristina Schulman, head of Latin America DCM at Santander.
It makes even more sense for Mexican issuers to address funding needs early, says Dukes. For investors, however, there is no rush.
“There is some headline risk around Mexico,” says Gorgoll. “We’re into the fifth round of Nafta talks and some days prospects do not look great. Our thinking is that we should be patient and wait for opportunities; there will be definitely more interesting days ahead.”
Yet if López Obrador’s apparent traction is worrying some, growth in Mexico should still pick up in 2018 — from 2.2% to 2.5% according to Capital Economics, or from 2.1% to 2.2% according to JP Morgan.
“The economy remains resilient even as uncertainty lingers on,” said the US bank in a November report.
The fact that even apparently risky Mexico is showing economic improvements is symptomatic of better fundamentals in the region. Capital Economics says that after a couple of “torrid” years, Latin American economies have turned a corner, as inflation has cooled in most countries and balance of payments adjustments have been made.
“Argentina is the only major economy where we expect growth to weaken, and even here the slowdown is likely to be modest,” says the research firm.
Gorgoll says that Latin America remains “first place” in EM in terms of the attractiveness of valuations, while JP Morgan begins 2018 overweight on the region’s bonds, given the “room for fundamental improvement” and highest yield level among EM regions.
“The region is also expected to see the most liability management exercises, which should support both technicals and valuations,” said the bank.
Brazil and Argentina are Gorgoll’s top two picks in Latin America, and she believes Argentine growth could hit 3% this year — in between Capital Economics’ 2.2% forecast and JP Morgan’s 3.3%.
All this should help the Argentine debt party, which tallied $25bn in 2017, continue apace.
Gorgoll is confident that there will be more corporate activity, especially in the electricity sector, that could bring more bond issuance. “This is particularly encouraging as most of these companies are strong fundamentally but are only rated single-B because of the sovereign, while still offering very good yields,” she says.
Brazil back from the brink
Argentina’s path to recovery now looks clear, after President Mauricio Macri’s successful mid-term elections in October last year, but views on Brazil are more nuanced. Typically, Brazilian bankers are the most pessimistic when it comes to their home country, and the lack of much-needed structural reforms and any realistic presidential candidate are leaving some fearing the worst.
But economists’ forecasts put Brazil as the driver for LatAm’s growth recovery — it could pick up from 1% last year to 2.5%-2.8% this year — and others are optimistic.
“I understand locals are more pessimistic, but if you take a step back and manage your expectations you can see that Brazil has come very far,” says Gorgoll.
“After three years of recession, we will see decent growth.”
On the issuance side, Brazil led the way in LatAm last year, with $29bn of volumes by November, after two years off the top.
“Things could go wrong and the elections will probably cause volatility,” says Schulman at Santander. “But if the economy grows, and given that BNDES is lending less, there could well be more companies looking to fund themselves in capital markets.”
Volkov at BAML suggests that “more M&A activity in Brazil may make up for less activity from typically frequent issuers”.
Gorgoll is keen to point out that she won’t be “blindly buying all Brazil” — she prefers certain banks and much of the protein sector — but she insists there are opportunities.
Venezuela default doubts
Yet in this Latin America of opportunities, bondholders live a dual existence, and other concerns look trivial when placed next to Venezuela.
The yields on offer mean that Venezuela is potentially the biggest opportunity of all. But so separate are its problems from the rest of the region that even Caracas-headquartered multilateral CAF — which has more exposure to Venezuela than any other country — escaped any contagion when President Maduro announced a debt restructuring in November.
CAF’s latest dollar deal in fact tightened from October’s re-offer spread of 70bp to 68bp by late November.
Investors now see an issuer that wants to restructure and makes all debt payments late, but at the same time insists it will keep paying.
The timing or even likelihood of what would be one of the messiest defaults ever is now up in the air.