Today, global capital markets are a complex collection of bubbles. Many commodities are trading near all-time highs – a frothy peak springing directly from Asia’s voracious manufacturing appetite combined with limited global supply capacity. (After all, who wants a new lead-smelting plant or refinery opening up in their backyard?)
Yet few asset classes are perched so precariously high as those that are a bubble on top of a bubble – notably Latin American equity markets.
Almost all equity markets in Latin America are trading near historical highs. The MSCI EM Latin Index has rallied to almost 2500, up 9% so far this year and a multiple of the levels near 500 seen in early 2003. This price run, judging by what the correlation function on Excel says, is more than 70% a result of the run-up in the price of West Texas Intermediate crude. Whether any Latin economy produces much WTI is irrelevant. Argentina does not export crude and Venezuela’s PDVSA pumps mostly Tia Juana Light.
The point is that in a new era where emotions about oil scarcity run high, Asia has enormous amounts of cash to invest, and Latin America is perceived as a big, endless supply of commodity wealth. Investment dollars have been flying blind into the local equity markets. Hot macroeconomic growth, improved corporate governance, strong bottom-line results – typical catch phrases to argue for overweighting a particular market – have thin relevance for Latin equity prices.
All this has been good news for the growing armies of retail investors that bought into Latin equity funds from their friendly financial advisers. Yet, these investors would have been even better served had they simply bought directly into the long end of an oil swap. Latin American equities are like gold stocks that closely parallel the price of gold. Both have been pushed sky-high by commodities yet, at the same time, both have also significantly underperformed their particular controlling commodity prices.
So far, no one has yet uttered the dreaded comparison – that today’s Latin markets are akin to Nasdaq at its peak in March 2000. Nonetheless, continued phenomenal Latin equity returns have little to do with micro-analysing company-specific fundamentals and everything to do with guessing the future price of oil. Investors should look closely at the daily pricing on Nymex, as the volatility on their Latin equity holdings will be nearly identical to the heated action in the WTI futures pit.