Optimism returns as storm clouds clear

Recent events have unsettled global equity markets after a promising start to the year. But there are enough bright spots to suggest recovery is well under way.

Brazil has 12 billion barrels of proven oil reserves. The rapidly growing country's main problem is inflation. Petrobras via Bloomberg News

The year started well in equity markets across the world. Investors were optimistic about the outlook, which would ordinarily have been a warning signal as important market moves usually begin when the mood is negative.

But earnings were strong and economies everywhere were improving, and stocks reflected the favourable fundamentals. The markets were ripe for a correction, however, and almost anything could have been the catalyst.

Events in the Middle East and North Africa (Mena), coupled with the earthquake and tsunami in Japan, unsettled markets everywhere. There was a sudden rush to liquidity, and currencies, commodities and bonds responded irrationally. Oil prices, which had risen over Middle East instability, declined because of concern about slower growth around the world.

Other commodities were also weak for the same reason. Japan may require more fossil fuel for electrical power generation if nuclear capacity is reduced, and some Japanese food production may be contaminated, requiring more imported supplies.

The 10-year treasury yield declined even though the Japanese, who hold the second-largest amount of US government securities after China, were likely to use their trade surplus to rebuild their country and not buy at Treasury auctions.

Gold also declined in the liquidity rush, even though it usually rises in periods of major uncertainty. This initial behaviour, since reversed, is mostly indicative of a world in which fear and a desire for current liquidity cause conditions at variance with what might have been expected.

I believe the situation in the Mena region will stabilise soon. Muammar Qaddafi's power will be reduced in Libya and the country may be divided into two parts. To remove Col Qaddafi from power will probably take forces from America and others on the ground, and the US President Barack Obama has clearly stated he will not authorise that.

By supporting the no-fly zone intervention, we are effectively providing aid to the Libyan rebel forces and their political objectives, other than being anti-Qaddafi, are unclear at this time.

Regime change will not move beyond Egypt and Tunisia. In spite of current demonstrations, I think Jordan and Syria will remain under their present leaders.

In Japan, the Fukushima nuclear facility will eventually be brought under control and the country will begin the recovery process. Japan's economy was improving before this happened. While it was shaken by this major nuclear incident, Japan is a remarkably resilient nation and the rebuilding could prove stimulative. There have been some plant closings and supply disruptions, but I believe these will prove to be temporary and most manufacturing facilities will be back to normal in several months.

The US economy was also gaining momentum before these events and GDP estimates were being raised.

While investors have China and India at the top of their emerging market focus lists, investment opportunities in Latin America continue to improve. Brazil is most notable because of its high level of food and oil production, giving it a favourable natural resource-to-population ratio, and investors have included that country in their favoured emerging markets for global portfolios.

Much less attention has been paid to other countries in Latin America in the belief that those markets are too small, or there are too few attractive companies there. Not many investors have positions in Chile, Peru or Colombia.

For some time, I have been wondering whether global portfolio managers are missing something, so I decided to go down there and talk to analysts and institutions to see if a broader approach to investing in Latin America should be taken. I spent time in Brazil, Chile and Colombia, and my overall conclusion is that South America is going to present global investors with abundant opportunities.

The countries have young populations yearning to improve their standards of living. Several of them have substantial natural resources including oil, gold, copper and iron ore. Most have made considerable progress in improving their infrastructure over the past two decades.

Brazil has a population of about two thirds that of the US and a GDP of about one tenth. Its per capita income is about one quarter of that of the US, and 26 per cent of its population lives below the poverty line. The country is growing at better than 5 per cent and the inflation rate is 4 per cent.

Brazil has a budget deficit of about US$80 billion (Dh293.84bn) and its public debt is about 60 per cent of GDP. The country has 12 billion barrels of proven oil reserves.

Its principal problem is inflation. Food prices are rising rapidly and food accounts for more than 30 per cent of the Brazilian consumer price index. The central bank there is curbing money supply growth to control the rise in prices, and the risk is that the tight monetary policy slows the rate of growth below 5 per cent.

Of all the Latin American stock markets, only Brazil seems large enough to attract serious investor interest at this time, with a total market value of $1.5 trillion. Chile, Peru and Colombia together have a market value of only one third of that amount.

While the circumstances in Japan may have a short-term negative effect on world growth, I believe this year will turn out to exceed the expectations held by economists at the end of last year. As for the equity markets, I expect them to move higher by year-end.

Byron Wien is the vice chairman of the Blackstone Group. The views expressed are his and do not necessarily reflect the views of Blackstone