This is the twelfth in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe.
The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.
In this article, we examine Colombia from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward.
Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.
The magic formula for success is:
P = G + X
And you can read more about that below.
Which Countries Are Doing Well?
The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.
The chart is from early December 2016. In that time positions have changed a little as the chart below shows.
One notices from the list the following items:
- Latin American countries head the list; what are they doing right?
- No European countries are lagging in the list, except Norway.
- Only three "developed" countries are near the top of the list.
- The U.S. is green and showing promise, though far down the list. Why?
- Mexico, a Latin American country, is near the bottom. Why? What is it doing wrong?
All these questions and more will be addressed in forthcoming articles on a country-by-country basis from top to bottom. Most countries on the list are in the red and are of no further interest, though we could learn from them what to avoid, as could their governments and politicians. But, as investors, we will leave that to them.
Since the start of this series of articles, Colombia has risen from twelfth to eighth place. Colombia is moving up the chart and is one of many Latin American countries in the green zone. Colombia shows a 40% growth rate over the last twelve months.
One can find the Global X MSCI Colombia ETF (NYSEARCA: GXG) near the top of the SA ETF list, and the current fiscal situation is as follows:
BMI View: The Colombian government will prioritize fiscal austerity after finalizing the peace accord with the Fuerzas Armadas Revolucionarias de Colombia (FARC). The fiscal deficit will narrow slowly over the coming years as austerity measures are tempered by decreased revenue from commodity sectors and new spending on public works projects negotiated in the treaty.
The Colombian government, still reeling from lower oil revenues, will turn its attention toward addressing its fiscal shortfall in the coming months. Fossil fuels makeup nearly two-thirds of Colombia's exports and the decline in average prices, particularly that of Brent crude from an average USD99.5/bbl in 2014 to our forecasted average of USD45.5/bbl in 2016, have harmed government intakes. Budget-wide spending cuts announced earlier this year were designed to mitigate the impact of revenue losses, however, the effect of this is unlikely to be felt before 2017. Therefore, we forecasted Colombia's fiscal deficit to equal 3.9% of GDP in 2016 from 3.1% in 2015. Beyond that, stabilizing oil prices (we forecast Brent to average USD57.0bbl in 2017 and USD62.0/bbl in 2018) and new austerity initiatives will combine with a gradually improving economy to narrow the gap slightly to 3.6% and 3.3% of GDP in 2017 and 2018 respectively. (Fitch)
The only good news from the Fitch report is that the war is over and that the deficit will close slowly. The main benefit Fitch sees is that there is a chance for wealth-sapping, economy shrinking austerity.
One must remember that Fitch writes from the perspective of a sovereign bond rating agency and bondholder. As such Fitch does not want to see rising yields and a falling face value for bonds. That the economy might shrink or that the prosperity and standard of living of the population might suffer as a result of maintaining Bond values and yields does not play a role in the analysis.
The main thing for Fitch is a fiscal surplus and a high credit rating despite the contracted sub-optimised economy this creates.
The near-term government budget picture is shown in the chart below.
The chart shows that the government sector is steadily declining the deficit and adding less money each year into the private sector. This is not a good trend for stock market investors.
The long-term government budget picture is shown in the chart below:
Long-term the government sector has been consistently net adding to the private sector and in total has been a supportive element for the private sector. Long-term though one does note that the trend appears to be for ever smaller deficits. This again is not a good trend, but on balance, the government sector can be seen as a positive force net adding to the private sector and always has.
Colombia has difficult official foreign trade position. The near-term can be seen in the chart below.
The chart shows that the balance of trade is negative and not supporting the private sector by net adding funds to it.
The long-term balance of trade picture is shown below:
The chart shows that Colombia has had at best a stable trade situation over the long-term. Decades of surpluses are followed by decades of deficits.
The official charts though do not tell the whole story. There are huge ($10B) untaxed (undrained) external inflows from drug trading that find their way into the economy and stock market and cannot help but buoy both. This offsets the official trade deficit over tenfold and makes for a healthy trade surplus. Whatever view one has on the drug trade the positive benefits of the net add to the Colombian private sector cannot be denied or ignored.
The chart below shows the near term flow situation.
The chart indicates that net outflows are draining the private sector in Colombia and this is not a good thing as it contracts the circular flow of income by that exact amount. The long-term trend is shown in the chart below:
Long-term the trend is grim indeed with consistent and growing net outflows draining the private sector.
Were it not for the illegal cash flow from drugs this would be a problem. What it does show though is that there is not a lot of confidence from foreigners wanting to invest in Colombia and that many Colombians are investing overseas rather than in their own country. Drug wars and revolutions tend to do that.
Sectoral Analysis Methodology
Each nation state is composed of three essential components:
- The private sector
- The government sector
- The external sector
The private sector comprises the people, business and community, and, most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, it needs income from one or both of the other two sectors to grow.
The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes.
The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine.
The external sector is trading with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance. One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.
For the stock market in the private sector to prosper and keep moving upward, income is required to be put into the flow. Otherwise, the sector can only circulate existing funds, or is being drained of funds and is in decline.
The ideal situation is that the private sector has a net inflow of funds and is constantly growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
This relationship can be expressed by the following formula:
Private Sector [P] = Government Sector [G ]+ External Sector [X]
For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.
Colombia is a buy and is on the move right now. Colombia ticks all the boxes with regards sectoral flow analysis, even if one has to look past the official figures and into the murky drugs underworld and the black economy.
The government sector is net adding to the private sector. The war is for now over; there is a commitment to infrastructure projects as part of the peace treaty and a threat of more war if they are not carried out. The government is, therefore, motivated to spend to maintain the peace.
Officially the external sector is a net drain on the private sector however when one accounts for the illegal drugs trade it is well in surplus and net adding to the private sector.
Capital flows are negative and getting worse however once again more than offset by the drugs trade which shows no signs of slowing or slackening demand. Drugs money is also untaxed (undrained), and so all of it remains in the private sector.
One can get investment access to Colombia via these ETF funds:
- iShares MSCI Colombia Capped (NYSEARCA: ICOL)
- Global X MSCI Colombia ETF
In the next article, we will take a look at South Africa as it has been moving up the SA Country ETF list lately and is becoming one of the top ten.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.