In much of Latin America, New Year’s Eve revellers eat 12 “grapes of luck” at midnight in the hope of ushering in 12 months of prosperity. After a fruitless 2018, LatAm bond investors will take any help they can get.
Starting the year heavily overweight on the region, bond buyers had absorbed a record $37.3bn of LatAm issuance by February 8. Then a US stock slump triggered a sell-off that kept finding reasons to continue — even if the fundamental outlook for the region was vaguely constructive overall.
“The common trigger for the tough year suffered by EM has been tighter global liquidity, and it would be wrong to conclude that LatAm was the problem,” says Graham Stock, head of EM sovereign research at BlueBay Asset Management.
By late November — despite year-to-date issuance volumes having only doubled since those first 39 days — the performance of the deals issued during those idyllic times made sorry reading.
Pemex’s $2.5bn 2028s issued at par on February 1 dipped below 85 on November 20. Argentina’s $4.5bn 2028s hit a low of 75 — 24 points below January’s re-offer price — and Ecuador’s $3bn 10 year fell 19.5 points over the same period.
Jennifer Gorgoll, senior portfolio manager in EM corporate debt at Neuberger Berman, says that this marks a “bad end to a bad year”, with concerns about global trade “weighing on the market and likely to continue to do so”.
Stock highlights that US rate rises are also likely to remain a headwind, meaning pressure on EM debt will probably continue. On the bright side, “the bulk of the adjustment” has already occurred, he believes.
This adjustment has some bankers believing the grapes will do their job.
“I am optimistic market conditions will improve in January,” says Max Volkov, head of Latin America DCM at Bank of America Merrill Lynch. The “challenging situation” investors are facing with this year’s returns means they “do not want to double down on risk”, he says.
“Once investors turn the clock and review the market, they’ll find robust spreads and higher rates; all of a sudden they can get back into the business of making a return.”
Lisandro Miguens, head of Latin America DCM at JP Morgan, also believes investors will “want to turn the page and start with a clean slate”.
He adds: “Monitoring outflows will be a key factor to determine sentiment in 2019.”
Grapes of wrath
Gorgoll, however, is more cautious about the prospects for the new year, comparing the market tone in November to similarly gloomy days of the commodity slump in late 2015. The new calendar year did not bring an upturn in fortunes then.
“In fact the tone remained very negative until the second week of February 2016,” says Gorgoll. “I don’t think we just flick a switch and have a spectacular January.
“More likely, market sentiment will continue to drag into the start of the year and we will gradually emerge from the slump later in Q1.”
At least there are reasons to believe this emergence can happen. Firstly, EM bond investors have cash.
“On the technical side, the picture is more constructive,” says Miguens. Since March, he says, net supply in Latin America — gross issuance minus coupon and amortisation payments, bond buybacks, tenders, calls and redemptions — has been negative to the tune of $32bn.
“In a market of our size that is a huge amount of cash returning to investors, which is crucial because it is fixing the strong overweight that investors had in Lat Am at the start of the year,” says Miguens.
Volatility on the grapevine
However, there is likely to be plenty of noise on topics like trade that could make life tricky for LatAm.
“I don’t think we will see less disruptive newsflow, so it is hard to predict a reduction in volatility,” says Cristina Schulman, head of LatAm DCM at Santander.
Stock mentions two further external factors that could affect LatAm debt: GDP growth in China and the US. He is “sanguine” on China, expecting growth to slow because of trade tensions, but that this could be offset by infrastructure.
“For Latin America, the infrastructure spending is a more important factor, so China’s situation should not be particularly concerning,” says Stock.
On the US, his concern would be if certain imbalances — particularly the overdependence on fiscal stimulus — start to bubble over.
“You might see benefits in terms of lower interest rates, but demand would be hit,” says Stock.
Among volatility’s victims was high yield: with issuance from LatAm in the first nine months of 2018 at its lowest since 2011, according to Moody’s. High volatility has meant investors strongly favour liquidity, according to Volkov at BAML. Moreover, the repricing across LatAm means that outstanding high yield paper is now trading exceedingly wide.
“There are a lot of discounted assets, and there is so much paper outstanding that it can be hard to persuade investors to buy bonds at the kind of yields that are acceptable to issuers,” says Volkov.
Most obviously, Argentine borrowers issued a combined $100bn between 2016 and April 2018. All of this is single-B rated or below, and the bulk is trading wider than the sovereign, which has a 10 year at nearly 10%.
Sadly, high yield companies are often those most in need of international bond markets. In the face of rising volatility, investment grade LatAm issuers have made good use of domestic capital markets and international bank markets this year, but both are difficult for the lower-rated.
Indeed, according to Miguens, LatAm loan volumes are in 2018 likely to pass the previous record of $50bn.
“Banks had already decided to increase exposure in LatAm and so were willing to support clients,” he says. “That meant that, while LatAm bond spreads widened, in the loan market they were either flat or tighter; the loan market took some of the slack. However, the loan market is not there for the genuine high yield credits, so at least some of them will have to tap the bond market.”
If investors say the fundamental picture in Latin America is mostly positive for both sovereigns and corporates, there are exceptions. Disruptive newsflow is not exclusively coming from outside the region, and Argentina provided “the real big surprise” for markets in terms of LatAm-specific events, according to Schulman.
Argentina’s peso lost half its value and bonds plummeted as a three year rally began to unwind once the country’s vulnerability was exposed.
As Stock of BlueBay highlights, a $57bn IMF programme has reassured markets and the new monetary framework “is clear and has done a good job of stabilising the peso”.
Miguens at JP Morgan believes that spreads should tighten and volumes increase in Argentina if there is good macroeconomic news and a continuation of consistent economic policies. However, the Argentine banker highlights one obstacle.
“Right now the investor community is very overweight Argentina and that becomes a hurdle to add positions,” says Miguens. “This should fix itself as the IMF money trickles down.”
Moreover, with the economy in recession, presidential elections are already looming. “If Macri or Cambiemos win, the yields in both local and hard currency Argentine debt will compress rapidly,” says Stock. “If the government fails to get re-elected, default is back on the agenda.”
Such binary possibilities reiterate that though 2018 was exceptionally busy politically for LatAm, political developments in 2019 could be more intriguing.
Alongside Argentina, Brazil — where right-wing Jair Bolsonaro won elections in October — and Mexico, whose left-wing president Andrés Manuel López Obrador (Amlo) took office on December, will take centre stage. “A clear election theme was the drift towards extremes, and this leaves big question marks in Brazil and Mexico, in particular,” says Stock.
The two countries account for around 60%-65% of the LatAm bond market, points out Miguens at JP Morgan, so have a big impact on overall volumes.
“There is optimism surrounding Brazil, with the prospects of the new government pursuing a market-friendly agenda, while there are some concerns for investors in Mexico at the moment,” says Miguens.
So much is at stake in these countries that, no matter the external environment, both will struggle in markets if they do not get it right.
“Previously I thought Mexico was a very safe place to invest but now it is hard to justify having a big position in the country,” says Gorgoll.
Mexico’s policies are already directly affecting debt investors, as the cancellation of Mexico City’s new airport threw the $6bn of bonds raised to finance the project into uncertainty. Amlo then made noises about targeting the banking and mining sectors, says Gorgoll — both of which have provided bond issuers.
“Pemex has sold off a lot and is arguably looking interesting, but it is hard to say at what level you should buy because there is so much uncertainty,” says Gorgoll.
Across the board, Brazil is considered the bright spot, though few will profess to more than cautious optimism, given the challenges facing Bolsonaro as he looks to pass crucial social security reform.
“Signs so far in Brazil have been positive, particularly regarding Bolsonaro’s willingness to let his economic team take the lead on economic policy,” says Stock. “2019 has the potential to be the year Brazil restores its lustre, but it is a long way before we can be confident about the prospects of success.”
Schulman, a Brazilian national, warns it “remains to be seen how much allowance the market will make for potential delays”.
Furthermore, new issue volumes seem unlikely to boom, given there is “a lot of excessive capacity” in Brazilian industry, meaning low capex needs, and most companies have completed refinancing efforts, she adds. But Bolsonaro’s victory has certainly triggered a shift in sentiment.
“It seems amazing, but given what has happened in Mexico and Argentina, Brazil is being viewed as a safe haven for LatAm corporate bond buyers,” concludes Gorgoll.
No one is under any illusions about the challenges facing LatAm in 2019. Investors will just be hoping that by the end of the year, their lucky grapes will have fermented into vintage champagne. GC