I have been in Latin America for the past week, meeting clients across the region. Travelling abroad always provides a fantastic opportunity to get a feel for what’s really going on in any given country and what’s on the minds of locals. On this occasion it was a particularly interesting time to be in Mexico, where the financial markets have nosedived in the past couple of weeks. The reasons reflect the growing global trend towards populism, which makes politics an even more important element to factor into investment decisions than usual.
Despite the difficult environment for emerging markets, Mexico was holding up better with investors feeling reassured by the new trade agreement with the United States. But the mood has soured since the recently elected, populist left-wing president, López Obrador announced he would halt development of a new international airport. This was justified by the result of a referendum involving barely 1% of the population, despite construction being one third complete. Investors were quick to fear the worst for what else the president-elect may have in store when he takes control of government next month and the Mexican peso fell sharply, along with its stock market and bonds.
Locals see little logic behind the decision but are not surprised – they recall the same thing happening in 2002. Across so many emerging markets, standards of governance remain the biggest risk to foreign investors whilst also holding domestic prosperity back. Over the last ten years the Mexican peso has fallen by 50% versus the US dollar and Latin America’s representation in the MSCI Emerging Markets index has fallen from 25% to 13%. Locals would have done well to diversify their investments overseas and may continue to in the future.
The theme of populism has been increasing around the world, with populist parties also winning elections in Brazil and Italy this year, whilst Donald Trump’s mandate was also reaffirmed last week in the US mid-term elections. Across most countries this reflects rising levels of inequality and a loss of faith in democracy. A recent survey across Latin America, run by Latinobarómetro in Chile, found that the number of people dissatisfied with democracy has increased from 51% to 71% since 2009. It’s no surprise that some of the highest levels of dissatisfaction were in Brazil and Mexico, where populist governments have been elected. Meanwhile, satisfaction was highest in Chile, Costa Rica and Uruguay, where standards of governance are generally higher and the rule of law more established.
These factors, along with a strengthening US dollar and fears around trade wars, have pummelled emerging market assets so far in 2018 and brought many down to attractive valuation levels. From these depressed levels we believe equities in emerging markets should provide strong returns over the next few years. However, we hold only modest allocations across our portfolios in recognition of the high risks involved, while we also hold many diversifying assets alongside them. Granted that developed market equities are not immune to political risk either – Italy and the UK are most worrisome today – but their well-established and entrenched institutional frameworks usually provide many safeguards that are so often lacking in emerging markets. Critically, we take an active and highly selective approach to making all such investments, to try and avoid the many spots of turbulence that lie in wait and provide investors with a smoother journey to their target outcome.