Latin American stocks catch up - ANGELA BARNES

Latin American markets have been hot, hot, hot this year. So hot in fact that they as a group are now trading on a trailing price/earnings multiple at just a 5- to 10-per-cent discount to developed markets, a far cry from the 60 per cent in 2002, according to Citigroup Global Markets Inc.

But that may be about to change. Geoffrey Dennis, Citigroup's chief Latin American strategist, suggested in a report released yesterday that the region is vulnerable to a near-term correction, or "at best, a pause," which would allow developed markets to lead the charge and outshine the Latin markets.

But he remains bullish on the region over the longer term and would view any pullback as a long-term buying opportunity.

Just how strong Latin American markets have been so far in 2007 can be seen by comparing the Peru Lima general index's 84-per-cent year-to-date advance, or Mexico's Bolsa index's 22-per-cent rise and Brazil's Bovespa stock index's 29-per-cent increase to that of the Standard & Poor's 500-stock index's 9.25-per-cent gain or the S&P/TSX composite index's 11-per-cent advance.

And it isn't just the Latin markets that have been flying high. "Emerging markets as a whole are now effectively at parity with developed markets," Mr. Dennis said.

He noted that emerging markets as a group have outshone global markets for seven consecutive years, which includes all five years of the current bull market. Emerging markets climbed 344 per cent from the October, 2002 trough, while developed markets advanced 138 per cent. "However, our basic valuation approach to global equity markets as a whole suggests that this trend could be about to change," he said.

He does not think that emerging markets are likely to trade at a premium relative to developed markets for a sustained period.

"Therefore, with the emerging market discount almost gone and developed markets (alone) still cheap to debt, emerging markets seem set for a period of underperformance," he said.

Mr. Dennis remains bullish on the markets, expecting that both emerging and developed markets will continue to rally, but with the latter taking over the lead from the former. He believes that the long-term fundamentals are supportive of a continuing bull market and doesn't see a bear market materializing until the U.S. economy goes into a recession and/or global growth slows sharply, which he believes won't happen until 2009 "at the earliest."

Some investors have suggested that emerging markets can trade at a premium to that of developed markets, an argument Mr. Dennis rejected.

He noted, for example, that the cost of capital is still higher in emerging markets.

"For Latin America, sovereign bond yields are higher by as much as 260 basis points relative to global bonds as a whole and by around 180 basis points relative to U.S. Treasuries," he said. Therefore, "the regional risk premium is not zero."

He also said that emerging markets are more volatile than developed markets.

Furthermore, he said the times when emerging market valuations have gone to a premium are usually after a long bull run, "which could be just the time that events could occur that cause risk appetite to decline again."

He upgraded the Mexican market to neutral from underweight and cut Chile to neutral. Brazil remains the sole overweight in the region.