Smart Solutions: Looking To Latin America

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OCEAN CITY – If you want to understand Latin America’s quiet but dramatic turnaround, look no farther than Brazil, where surging commodities prices and savvy fiscal policy have driven a newfound prosperity mirrored throughout most of the region. Newly minted as a net creditor, Brazil is enjoying its second straight year of 5% GDP growth and recently received a coveted Standard & Poor’s investment-grade rating on its sovereign overseas debt. It is even planning its own sovereign wealth fund to help see to the ongoing health of its currency.

But Brazil is by no means the region’s only success story. In fact, the MSCI Emerging Markets Latin America Index of regional stocks has risen eightfold since September 2002. These are impressive developments in a part of the world that has often been historically marked by economic volatility. The question for U.S. investors is, can Latin America continue to provide investors with opportunities for solid growth? According to Felipe Illanes, Merrill Lynch Lead Economist for Latin America, the answer is yes. But Illanes warns that investors must be selective — not all Latin American economies hold the same potential.

Today, Latin America produces almost half of the world’s soybean crop, 40% of its global copper supply and almost 10% of crude oil worldwide, according to the Yale Center for the Study of Globalization. With commodity prices doubling since mid-2002, as measured by the Reuters/Jefferies CRB Index of 19 commodities, countries in Latin America have been among the clear beneficiaries.

“With the rise in oil prices,” says Illanes, “we’ve also seen the region’s main oil exporters — Mexico, Venezuela and Ecuador — benefit. Then you have the world’s leading copper producers, Peru and Chile, flourishing from rises in the demand and price for the metal. And more recently, Brazil and Argentina, the region’s main producers of grains such as soy and wheat, have reaped the rewards from increases there as well.”

But what happens in the event of a U.S. slowdown? Historically, Latin America’s fortunes have been strongly tied to the U.S. That is changing, says Illanes, because many Latin American countries maintain growth prospects independent of U.S. economic cycles. Driving that growth are globalization and strong fiscal decision-making.

Rapid changes in the global marketplace, particularly in Asia, have made many economies in Latin America less reliant on already declining exports to the United States. Underscoring the point, Brazilian and Argentinean soy exports to China have skyrocketed—from $360 million in 1999 to $3.6 billion in 2004, according to the Yale Center for the Study of Globalization. China also imports nearly 50% of its copper from Chile and Peru.

At the same time, many Latin American governments are making prudent use of their windfalls. “By and large, these countries chose not to spend the bonanza they’re receiving from higher commodity prices,” says Illanes. “Instead, they have built stronger external balance sheets through buybacks of external debt and accumulations of foreign exchange reserves. These efforts should give many Latin American economies greater cushions to resist softening demand from the U.S.” They will also enjoy greater protection in the event that commodities markets weaken.

Consumers in Latin America share their governments’ preference for saving, notes Richard Bernstein, Merrill Lynch Chief Investment Strategist. “Our Research Investment Committee has discussed many times the long-term investment opportunities that exist based on non-U.S. households’ higher savings rates,” he says. Bernstein believes the financial sector could have significant potential for growth during the next decade by managing and leveraging that pool of savings, especially by offering credit products such as mortgages, auto loans and credit cards.

When choosing where to invest in Latin America today, Illanes favors three countries: Brazil, Chile and Peru.

In the case of Brazil, Illanes forecasts 2008 GDP growth of 4.6%.

Chile’s estimated 2008 GDP growth stands at 4.2%.

In copper-rich Peru, Illanes anticipates 2008 GDP growth of 7%.

“Peru’s strong fiscal moves —including the attainment of a fiscal surplus — have led to a coveted ‘investment grade’ sanctioning of its foreign currency debt by Fitch,” says Illanes. “Moreover, Peru has secured a free-trade agreement with the U.S., which will help it expand its base for diversifying exports beyond metals.”

Although there are still bound to be stumbles in Latin America’s emerging markets, the region is enjoying both increasing stability and the development of a true consumer class. Each of these trends presents opportunities for risk-tolerant investors. While globally minded investors continue looking east to Asia and west to Europe, it may make a lot of sense to look south as well.

(A Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-8520.)

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