Asset Class Strategy: Relative Value Takes Centre Stage

  • Significant volatility in emerging market (EM) assets means that relative value plays within EM are an increasing focus for us, exemplified by our bullish view on Mexico's IPC equity index over Chile's IPSA.

  • Increasingly fierce competition for capital within Latin America in the coming quarters will favour those countries with investor-friendly policies, such as Mexico, Colombia, Chile and Peru, while Brazil will remain at risk of losing its status as a major regional investment destination.

  • With our major macroeconomic views for Latin America largely unchanged, we continue to prefer assets more closely tied to a recovering US economy over a multi-quarter to those with high exposure to slowing Chinese growth and lower industrial metals prices over a multi-month time horizon.

With our view for investors to increasingly differentiate between emerging market (EM) assets on the basis of macroeconomic fundamentals having been put on hold by weak US economic data and an uptick in political risk in Russia and Ukraine, which have hit many EM assets hard, we are increasingly focused on relative value plays within EM ( see 'Asset Class Strategy: Differentiation On Hold For Now', February 25). Globally, this has seen us add a bullish Turkish lira over Russian rouble view to our Asset Class Strategy in recent weeks ( see 'Going Bullish Turkish Lira Against Russian Rouble', March 18). In Latin America specifically, we express our preference for Mexico's benchmark IPC equity index over Chile's IPSA in our Americas Asset Class Strategy ( see 'Bullish Mexico's IPC Over Chile's IPSA', March 20).

The recent rally in Latin American FX and equities could have further to run in the near term. However, the precipitous drop in industrial metals prices in recent months and our view that a significant Chinese stimulus programme is unlikely, reaffirm our core convictions for slower growth and further downside pressures on exchange rates and equities in Latin America's major metals exporters, Chile, Peru and Brazil, this year ( see 'Regional Currencies To Face Renewed Depreciatory Pressures', March 28).

Stronger Fundamentals To See IPC To Outperform
Ratio Of Mexico's IPC Equity Index Over Chile's IPSA

Asset Class Strategy: Relative Value Takes Centre Stage

  • Significant volatility in emerging market (EM) assets means that relative value plays within EM are an increasing focus for us, exemplified by our bullish view on Mexico's IPC equity index over Chile's IPSA.

  • Increasingly fierce competition for capital within Latin America in the coming quarters will favour those countries with investor-friendly policies, such as Mexico, Colombia, Chile and Peru, while Brazil will remain at risk of losing its status as a major regional investment destination.

  • With our major macroeconomic views for Latin America largely unchanged, we continue to prefer assets more closely tied to a recovering US economy over a multi-quarter to those with high exposure to slowing Chinese growth and lower industrial metals prices over a multi-month time horizon.

With our view for investors to increasingly differentiate between emerging market (EM) assets on the basis of macroeconomic fundamentals having been put on hold by weak US economic data and an uptick in political risk in Russia and Ukraine, which have hit many EM assets hard, we are increasingly focused on relative value plays within EM ( see 'Asset Class Strategy: Differentiation On Hold For Now', February 25). Globally, this has seen us add a bullish Turkish lira over Russian rouble view to our Asset Class Strategy in recent weeks ( see 'Going Bullish Turkish Lira Against Russian Rouble', March 18). In Latin America specifically, we express our preference for Mexico's benchmark IPC equity index over Chile's IPSA in our Americas Asset Class Strategy ( see 'Bullish Mexico's IPC Over Chile's IPSA', March 20).

The recent rally in Latin American FX and equities could have further to run in the near term. However, the precipitous drop in industrial metals prices in recent months and our view that a significant Chinese stimulus programme is unlikely, reaffirm our core convictions for slower growth and further downside pressures on exchange rates and equities in Latin America's major metals exporters, Chile, Peru and Brazil, this year ( see 'Regional Currencies To Face Renewed Depreciatory Pressures', March 28).

Moreover, once capital begins to return to emerging markets in the next several quarters, we believe that the competition for capital within Latin America will grow increasingly fierce, with those countries that have enacted market-friendly policies and reforms, such as Mexico, Colombia, Chile and Peru, most likely to benefit, while Brazil will remain at risk of losing its status as a major regional investment destination ( see 'Regional Financial Account Surpluses Unlikely To Return To Recent Highs', April 7).

Equities: Sticking To Our Fundamental Convictions

We previously highlighted our view that Mexico's IPC equity index could offer significant value over a multi-quarter time horizon, as strengthening economic activity and rising investment into the energy sector were likely to bolster the index ( see 'Asset Class Strategy: Differentiation On Hold For Now', February 25). Our Americas Asset Class Strategy view for the IPC to outperform Chile's IPSA in the coming months chimes well with our conviction that equity indices more closely tied to accelerating economic activity in the US will outperform those with heavy exposure to slowing Chinese growth and weakening industrial metals prices this year ( see 'Mexico's IPC Looking Attractive Against Chile's IPSA', March 12). While the ratio has broadly traded sideways in the last few weeks, we expect that continued signs of a pick-up in growth in Mexico will see it move more significantly in the IPC's favour in the coming months.

Stronger Fundamentals To See IPC To Outperform
Ratio Of Mexico's IPC Equity Index Over Chile's IPSA

FX: Exploring Crosses Beyond The Dollar For COP And MXN

While we had highlighted bullish short-term technicals for the Brazilian real, Chilean and Colombian pesos, a lack of fundamental conviction meant that we were slow to put these views in our Asset Class Strategy. Moreover, with the US dollar likely to be bolstered by improving US economic data following a slowdown due to poor weather in the last few months, alongside our view for lower average industrial metals prices, we believe that several currencies, notably the Chilean peso and Brazilian real, will face renewed depreciatory pressures going forward ( see 'Regional Currencies To Face Renewed Depreciatory Pressures', March 28).

COP Has Come A Long Way Already
Colombia - Exchange Rate, COP/USD (Weekly)

While we believe that the Colombian peso's recent bounce could be starting to run out of steam, as the unit is approaching resistance around the COP1,930/USD level and the central bank remains biased towards a weaker currency, we are exploring the potential for the COP to appreciate relative to the CLP over a multi-month time horizon. Stronger economic activity and rising interest rates in Colombia underpin our forecast for the COP to appreciate in the coming months, while we expected renewed depreciatory pressures on the CLP due to a relatively loose monetary policy and lower average copper prices this year, Chile's main export. Indeed, we have seen a break through key resistance for the COP versus the CLP in recent weeks ( see chart below), which could presage a further move higher following a period of short-term consolidation.

A Big Break To Presage Further Gains For COP?
Exchange Rate, COP/CLP

In addition, we are increasingly constructive towards the Mexican peso verus the euro. Regular readers will know that we remain positive towards Mexican assets this year, expecting that stronger growth and rising investment into the energy sector will bolster both equities and FX. While the Mexican peso is highly volatile against the US dollar, and we expect similar trends to drive the trajectory of both units, we believe that the MXN/EUR is a more attractive cross. Indeed, we expect weakness in the euro over a multi-quarter time horizon, as growth in the eurozone will remain anaemic this year and risks of deflation will persist.

MXN Set For A Run Against Euro?
Exchange Rate, MXN/EUR

Moreover, we have seen the peso break key resistance against the euro in recent weeks, which could pave the way for a more sustained move in the peso's favour in the coming months. Furthermore, we have previously highlighted that net non-commercial speculative positions on the Mexican peso remain near multi-year lows, and a reversal could see a sustained appreciation in the unit ( see 'Shifts In Sentiment To Reduce Headwinds On MXN', March 18).

Fixed Income: Highly Selective In Light Of Challenging Dynamics

Potential for rising developed market yields to continue seeing capital outflows from EM debt and our view for further weakness in many major regional currencies this year makes it a tricky environment for fixed income. As such, we remain highly selective when assessing views.

Inflation Print Will Be Key For Rate Swaps View
Mexico - 2-Year TIIE Interest Rate Swap, %

One of our strongest convictions in recent months has been that interest rate swaps in Mexico, expressed through the 2-year TIIE, would head higher ( see 'Initiating Pay Fixed/Receive Floating Mexico 2-Year TIIE View', October 25 2013). While this view has played out relatively well in recent months, with swaps climbing in line with an uptick in inflation, we will be watching Wednesday's full-month March inflation print closely. Should it confirm that headline consumer price inflation has dipped back within the central bank's inflation tolerance band, it could prompt us to revisit this view.

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