Feeble Economic Outlook Argues for Demoting Peru’s Stocks from Overweight to Market Neutral

A 6.3 percent decline in the performance of Lima’s stock exchange (IGBVL) in US dollar terms thus far in 2014 might seem a notable improvement from last year’s dreadful 30.3 percent nosedive.  Indeed, dismissing a recovery of 240 basis points in return to the upside from last year’s abysmal outcome would gravely understate the resilience of an emerging equity market that is so deeply dependent on a vast array of export commodities for sustaining the growth of Peru’s domestic economy and foreign exchange reserves.

Moreover, the cumulative achievements on the fiscal, monetary and currency management policy fronts of a succession of governments since the election of President Alejandro Toledo, who boldly initiated wide-ranging economic reforms during his five-year term from 2001 to 2006, have prevailed in fortifying the competitiveness of Peru’s export sector and restoring the country as a vibrant South American destination for foreign direct investment.  Yet, while Global Markets Intelligence (GMI) stands by its largely upbeat assessment of the policy climate in Lima, it deems the political environment under the current president, Ollanta Humala, as potentially disruptive to constructive policymaking ahead of the 2016 presidential elections, dissuading GMI from retaining an overweight of Peruvian shares until the incumbent unequivocally commits his regime to policy stability.

What appears of greatest concern is the rapid turnover in ministerial positions of the Humala administration.  In the three-years since Humala assumed power, Peru has seen five prime ministers come and go with the latest, Ana Jara, appointed just four months ago.  Among appointments to key cabinet positions, Humala may have made only two during his tenure to the Ministry of Economy and Finance and the latest, Alonso Segura, would have appeared a normal change in ministerial staff were it not for the fact that Peru’s economic performance is quickly emerging as a campaign issue for the president.

The replacement of a seasoned, former World Bank economist – Miguel Castilla, the longest serving member of Humala’s government who outlasted five cabinet chiefs – by a comparatively unknown presidential adviser smacks of an official endeavor to politicize the policymaking apparatus scarcely less than two years before the next presidential election.  Needless to say, investors should be troubled that Humala will most certainly press Segura to initiate populist measures for recharging domestic demand and depreciating the currency at the cost of Peru’s debt management accomplishments in order to get Humala re-elected to a second presidential term.

Apart from political influences infiltrating and distracting sound fiscal and monetary policymaking, no near-term let-up of weakening overseas demand for the nation’s revenue-generating extractive commodities will continue to dampen the pace of growth in Peru’s macro-economy.  An anticipated slowdown in economic activity to 3.5 percent or perhaps less appears highly probable as a result of worsening terms of trade owing to descending commodity prices and decreasing demand from abroad.  Running at 1.2 and 1.7 percent rates of advance from the same period a year ago in August and the second quarter of 2013, respectively, national real GDP growth (measured on an either monthly or quarterly basis) is unlikely to rebound in any meaningful way prior to 2016 because only a limited rebalancing of demand from external to internal sources is achievable on account of Peru’s lopsided reliance on commodity exports for stoking economic momentum.

From an absolute valuation standpoint, the IGBVL stock exchange’s positive-adjusted, one-year forward price-earnings multiple (p/e) of 16.1x in US dollar terms may appear inexpensive compared with that of Colombia (17.0x), Mexico (19.6x) and Chile (17.9x).  Still, it is comparatively more expensive than that of Argentina (7.9x) and Brazil (11.7x) as well as that of Latin America (14.1x) and emerging markets (11.8x) compositely.  Also, it understates its record high of (28.5x), far exceeds its all-time low (2.8x) and is 5.5 points above its historical average (10.6x).  Compared with its MSCI Latin America bellwether, the IGBVL is 0.29 point overvalued on a relative basis.

In spite of the mixed picture presented by the IGBVL’s gauges of absolute and relative valuation, the political, economic and external payments could prove potentially problematic not just for Humala’s government, but for foreign investors in the immediate future.  If the regime were to reposition its policy priorities definitively in the direction of populist measures for jumpstarting the economy, it would run the risk of sidetracking the country’s enviable progress in narrowing the fiscal gap and restraining the growth of the national debt – which, on top of cyclically weaker economic fundamentals and current account deterioration, would intensify investors’ already waning confidence in Peru’s shares market and deter external direct investment.  Considering the uncertainty of the direction of economic policymaking in addition to the susceptibility of the macro-economy and balance of payments to downside influences, GMI recommends lowering exposures to the Peruvian equity market from an over- to a market-neutral weighting.

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