Geopolitical Developments: LatAm Constrains Biden and the US Economy

Troubles around the globe coalesce for investors into a recipe for low but steady economic growth in the US and Europe, buffeted by moderately higher growth in South and East Asia. US firms have in the past wrung out profits from slow growth and confidence runs high this trend persists. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is neutral. Yesterday's action across fixed income, currency and commodity markets signified no meaningful changes to the global macro environment. Though the market failed to pop the rounding top formation yesterday, the consolidation across global asset classes suggests the same action in equities. Consequently expect the S&P 500 to be range-bound near its all-time highs over the next few days.

The horrors of Afghanistan are now an Asian problem rather than an American or European one, since it’s unlikely terrorists can gain much foothold while the Taliban focuses on uniting itself and gaining cash to stabilize the nation. For the US the major geopolitical issues are now Kim Jong Un, cybersecurity, Iraq/Iran, stability in the South China Sea and immigration from Latin America. It’s this last issue which affects domestic US politics the most, and the troubling developments of late signal the Biden economic agenda will likely be toned down as he struggles to unite the Democrats over immigration reform.

LatAm’s problems are corruption and idiotic ideologies. Mexican leader Lopez-Obrador (AMLO) is an ideologue of leftist populism despite having no historical or intellectual basis for such an unwieldy perspective. But since Mexico has made little net progress over 30 years of reformist center-left and center-right administrations, AMLO’s charisma dominates politics and assures his party of control for the intermediate term. Unfortunately the economy suffers and that drives Mexicans to migrate to the US, burdening the Democrats with an intractable issue.

AMLO needs the private sector to be as confident as his supporters in order to gain tax revenues with which to reform the Mexican economy. This isn’t likely, since the recovery is falling short of getting Mexico to normalcy. Fitch notes in Mexico a “steady economic recovery and improving financial performance, particularly at Mexico's largest banks, will support banking sector stability over the medium term... Fitch is likely to revise up its Mexican GDP growth forecasts (currently 5.3% for 2021 and 2.7% for 2022) after stronger-than-expected performance in 2Q21. The banking system's improving profitability in 1H21 outpaced expectations as credit quality deterioration was less than expected, particularly at large banks that frontloaded provisions in 2020.”

But low vaccination rates constrain the economy from reaching pre-COVID levels.. Fitch further notes “Despite these positive indications, Mexican banks' Operating Environment (OE) trend continues to be negative. Mexico's still-low full vaccination rate of about 27% and the government's lower propensity to support the economy relative to LatAm peers make the economic recovery vulnerable to further waves and lockdowns. Notably, some smaller banks saw higher losses and lower profitability in 1H21 as most of these entities did not provision in advance, unlike their larger counterparts…Mexico's economy will rebound partially in 2021 from the 8.3% decline of 2020, though the nominal level of GDP in USD will remain below pre-crisis levels until 2022.”

And politically Mexico is going the wrong way in regards economic growth. Fitch notes “Policy risks remain for Mexican banks; legislative initiatives to cap interest rates and fees introduced by the Morena party in the Senate will not be a priority under the current legislative agenda. If passed, however, these would negatively affect bank profitability, suppressing product offerings and the extension of credit.”

South of Mexico the Northern Triangle + Nicaragua make the situation worse, as each nation competes to introducing new corrupt policies. Guatemala and El Salvador have removed their anti-corruption commissions, while Nicaragua is gutting its democracy and Honduras is in thrall to drug barons. In South America the situation is little better. Venezuela is focused on the 5th attempt to negotiate a settlement between a divided opposition and a ruthless military-backed dictatorship, with little hope either side will act in good faith. In Peru the situation is stable but not good, as all risks are to the downside. Reuters notes “Peruvian dollar bonds fell slightly on Thursday and the sol tumbled to near record lows after a Moody's downgrade...(of) Peru's rating by one notch to 'Baa1' on Wednesday, citing a "continuously polarized and fractured political environment...” And Brazil is little better, Reuters noting “Brazil's economic outlook appears bleak unless the government adopts structural reforms to build confidence in the country's financial health, Arminio Fraga, a former governor of the central bank, told the Reuters Global Markets Forum on Wednesday.”

My current market positions are in Activision (ATVI), American Express (AXP), Johnson & Johnson (JNJ), 3M (MMM), Pfizer (PFE) and Starbucks (SBUX), and a short position in the SPX (UPRO and SPXU).