Brazilian stocks and U.S. rate cutFrom today's Globe and Mail:
U.S rate cuts tend to fuel Latino stocks - but analysts wary
DAVID PARKINSON
Globe and Mail Update
September 26, 2007 at 9:07 AM EDT
U.S. Federal Reserve Board rate cuts may spell fiesta time for Latin American stocks, but some analysts wonder if the party could end with a bang.
Pedro Martins, Latin American equity strategist for Merrill Lynch & Co. Inc., has found that in the past three U.S. rate-cutting cycles, the region's equity markets have rallied an average of 9.4 per cent in U.S.-dollar terms in the two months after the onset of cuts. The trend is so far intact in the new cutting cycle, kicked off by the Fed's decision last week to slash its benchmark federal funds rate by half a percentage point.
Morgan Stanley Capital International's Latin America index is up 9 per cent since the Fed's Sept. 18th announcement.
"[The] lower fed funds rate should lead to higher risk appetite [and] lower volatility, favouring high-beta assets in global portfolios," Mr. Martins said in a recent report.
While that scenario favours emerging markets in general, Latin America is particularly well positioned to take advantage, due to its relatively cheap valuations. Latin American equities are trading at a 12-per-cent discount to the broader MCSI Emerging Markets index based on forward 12-month price-to-earnings multiples (13.7 times versus 15.6 times), and a 16-per-cent discount to developed market equities.
The region's heavyweight, Brazil, has historically shown the strongest performance after the cutting cycle begins, jumping an average 13.1 per cent. Brazil's Bovespa stock index is up 7.7 per cent since the Fed announced its latest cuts.
Given its cheap 12.8 times forward P/E, solid domestic demand and healthy growth outlook, Brazil is Merrill Lynch's top pick among Latin American markets.
Analysts at BCA Research, an independent market research firm based in Montreal, noted that the relatively cheap valuations for emerging market equities had already been giving those markets a lift prior to the Fed announcement. "They offer better value and growth profile than most developed markets," BCA analysts said. The rate cuts - which were aimed at easing tightening credit markets - are likely to add to that strength.
"The reversal in the liquidity squeeze will revive the bull markets in risk assets."
They added that emerging markets weathered the recent credit crunch storm "reasonably well." That is indicative of the improved economic stability in the developing world over the past several years, as well as the declining dependence on the U.S. economy as major regional powers such as China, Brazil, India and Russia have emerged.
"The relative strength of fundamentals in the emerging markets ... is a broader story, and the shift to allocate capital toward them is tied up to the broader rebalancing of global demand that has started but is still incomplete," wrote economist Dominic Wilson of Goldman Sachs in London.
Still, many analysts consider a full-fledged U.S. recession to pose the biggest risk to emerging markets, which have traditionally been highly sensitive to economic cycles and have underperformed when investors seek out defensive positions in bad times.
But another Merrill Lynch expert - global emerging markets strategist Michael Hartnett - suggests emerging markets could actually face bigger trouble in the longer run if there's no recession.
Mr. Hartnett likened the current scenario to that of 1998, when the Fed cut rates to tackle a financial crisis when no recession was in sight. The result was a wave of liquidity that fuelled bubbles in technology stocks and Japanese equities - both of which ended badly.
"If the global economy avoids recession ... then we continue to forecast an investment 'bubble' in the fundamentally strong emerging markets," he said.
"In our view, rate cuts in 2007 may well prove the last great buying opportunity for emerging markets equities."