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ETF Specialist

Latin America: A Bet on China's Rise

We don't know if and when Latin America will dismount the Chinese dragon, but risks are growing.

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Latin American stocks are an indirect bet on China's infrastructure boom. Let me explain: China's mandarins pumped credit into China's economy during the financial crisis to ward off the effects of collapsing global demand. Latin America's commodity exporters have reaped the fruits of the resulting construction boom, tying the region's fortunes to China's fiscal and monetary policy via commodity prices. The correlations are telling. In the two decades before 2007, the S&P Latin America 40 Index's rolling three-year correlation to commodity prices, proxied by the Goldman Sachs Commodity Index, rarely rose above 0.30. Rolling correlations have since shot up to 0.80.

Granted, rising commodity prices have helped set off a virtuous cycle of credit expansion and asset appreciation, lending internal momentum to the region's growth. Despite it, Latin America hasn't decoupled from the West's woes. Witness how the region's equity markets have cratered during the eurozone crisis. If anything, Brazilian stocks behave like turbocharged exposure to world markets in part, thanks to a vibrant carry trade (in addition to the Chinese export link we mentioned). Even after recent cuts in Brazil's benchmark SELIC interest rate to under 10%, Brazilian bonds are among the highest yielding in the world. The high rates have attracted a lot of foreign capital from low-yielding markets, elevating the real to one of the priciest currencies on a purchasing-power parity basis. Dents to Brazil's economic outlook will hurt equities and spur further rate cuts, which in turn will hurt the real and wallop equities again.

Samuel Lee does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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