The top-performing region through Monday night's close was Latin America, which has climbed an astonishing 41% in dollar terms (this and all data are courtesy of S&P/Citigroup Global Equity Indices). In fact, double-digit gains remain the norm for much of the planet's stock markets, with Japan being the conspicuous exception.
This year's rally may reflect rational pricing of assets, but the gains in Latin America are inducing some head scratching. Indeed, the region's relative strength is conspicuous this year, but it's hardly a new trend. BCA Research last week observed that Latin America has outperformed Asian markets for nearly 20 years. "This is remarkable, given strikingly superior economic performance in Asia relative to Latin America," the consultancy wrote.
Some of Latin America's equity leadership can be attributed to the fact that the region is relatively rich in commodities compared to Asia. Among the obvious examples are Chile which is a major copper producer, and Venezuela which is among the world's biggest exporters of crude oil. The bull market in commodities, then, solves the puzzle for why Latin American stocks are running hot for so long, right? Well, only partly. The commodities rationale isn't completely persuasive, BCA advised, noting that Latin America also outperformed in the 1990s even though commodities prices were weak in the decade.
Latin America may look frothy to some, but the case for applying the label remains debatable based on the fundamentals. Skeptics point out that Latin America's dividend yield, at 1.45%, is near the bottom among regions while its price-to-book ratio (3.12) is near the top, as of June 30, 2007. Yet trailing 12-month P/E of 6.1 for Latin America looks like a bargain compared with almost everywhere else. Emerging markets overall, for instance, posted a P/E of 12.2 midway for this year. Meanwhile, Latin American return on equity is near the top among regions at a hefty 19.7.
Valid or not, the case for staying bullish on Latin America continues to sign up new subscribers. Earlier this month, Marketwatch.com reported that Latin America-focused equity funds boasted their 17th straight week of net investment inflows and accounted for the lion's share of recent new investments. All of which proves once again that potent gains bring capital inflows, which in turn boosts returns that bring more inflows.
The virtuous cycle is alive and well in the lower hemisphere. Bullish news seems only to beget more of the same. Calpers, the largest U.S. pension fund, recently reported that it was making a sizable investment to emerging markets including Latin America.
Perhaps the biggest challenge for investors trying to cash in on the Latin American bull market is finding the discipline to ignore Mr. Market's implied portfolio weight for the region. Using S&P/Citigroup numbers, Latin America represents just 23% of market capitalization for emerging markets overall - half as much as Asian emerging markets. And on a global basis that includes developed as well as emerging nations, Latin America's represents a mere 2% of total market cap.
Given the extraordinary trailing performance in Latin America, it's likely that performance-hungry investors are overriding Mr. Market's suggested asset allocation. By the all-knowing wisdom of the rear-view mirror, such decisions still look brilliant.