When Investing in Latin America, Politics Point the Way to Profits

Brazil's election win by the Workers Party candidate Dilma Rousseff has cast a dark shadow over the investment prospects of that long-fashionable "BRIC" economy.

And it has underscored an important lesson for investors: In Latin America, the political climate is really the No. 1 factor in determining where to invest for the long run.

In short, when looking to invest in Latin America, let politics be your guide to profits.

Different RulesThis isn't true in parts of the world beyond Latin America. In those markets, while investors must still keep an eye on the political picture, there are many other factors that in most cases are more important when deciding where to put your money.

For instance, many investors have made excellent money investing in Sweden and Germany while those countries were under social-democratic rule. And even Great Britain did pretty well for investors during the early years of the center-left premiership of former Prime Minister Tony Blair.

The same is true for China, where long-term investors have done quite well - even though the county is still nominally run by communists.

India is a more complex situation: It elects a succession of Congress Party governments (often with communist support), who don't try hard enough to control public spending. But since 2004, the new regimes have at least had the good sense to not destroy the prosperity that their center-right predecessors had left them.

In Latin America, while there are sometimes short-term rallies under leftist governments, the overall picture is different. The line between right and left is quite severe ... most likely a cause of - and a result of - that continent's glaring income inequalities.


A Country-By-Country StrategyIn Latin America, there are some variations from country to country, some of them significant enough to influence profit potential. It's well worth taking the time to examine the regimes from country to country.

Let's take a look.

What follows is a country-by-country analysis, including our current investment rating.

Mexico: In Mexico, the center-right PAN (National Action Party) has theoretically been in power since 2000. In practice, it has proved completely unable to unravel the nexus of leftist and union control left by the 71 years of PRI (Institutional Revolutionary Party) rule that took place from 1929-2000. For example, Mexico's oil sector remains completely dominated by the state controlled Petroleos Mexicanos (PEMEX), and repeated attempts to allow foreign participation have failed - foreign oil companies have been in bad odor in Mexico since the oil business was nationalized by President Lazaro Cardenas in 1938. Thus, Mexico has appalling productivity growth - indeed its productivity is still lower than at the peak of the pre-crisis boom in 1981. A few politically connected billionaires dominate its industry and entrepreneurship is minimal. Avoid.

Argentina: Here was a country that seemed headed toward a free-market-style economy in the 1990s and became a very fashionable investment destination. However, Argentina had the bad luck to have its free-market push coincide with very low commodity prices, so the commodity-dependent Argentine economy did not prosper, and ran up debt until going bankrupt in 2001. Since then, there has been some recovery as commodity prices have soared, but foreign investors have been treated badly and there is little likelihood of any truly successful Argentine private-sector growth stories. Avoid.

Venezuela: As stunning as it sounds, this country has lower productivity today than it had back in 1957; the country was badly run even before Hugo Chavez came to power in 1998. These days, every foreign company is liable to be nationalized. Avoid.

Brazil: This was well run in the 1990s, but entered a crisis in 1998-2002, which led to the election of Workers Party President Luiz Inacio Lula da Silva in 2002 - and almost to bankruptcy. In his first term in office, Lula did a surprisingly good job; he kept public spending down, except for the Bolsa Familia system of payments to poor families who kept their children in school. That was genuinely useful in reducing Brazilian inequality, and only moderately expensive - about 0.5% of Brazil's gross domestic product (GDP). However, in his second term Lula increased public spending excessively, especially in the run-up to the 2010 election, and meddled with property rights in the energy sector. Rousseff, the new president, appears somewhat left of Lula and is a firm believer in government control. Thus, even though Brazil has done well under Lula, that progress is likely to end in a financial crisis - and to lead to meddling in such major Brazilian companies as Vale SA (NYSE ADR: VALE). Avoid for now, though Brazil could well become a "Buy" again if it gets cheap enough - its decline in inequality may make its politics work better in the long run.

The Two Markets to Buy NowThere are two Latin American countries where investment is attractive:

• Chile: The Chilean economy was revolutionized by President Augusto Pinochet in the 1980s, with most major state-owned companies being sold and the world's first private-sector universal pension scheme being introduced. Fortunately, the center-left governments that ruled from 1990-2010 had the sense not to meddle with Pinochet's reforms. What's more, when copper prices rose after 2003, the government used the proceeds of copper sales to form a $19 billion Stabilization Fund, which came in very handy in the 2009 slump. With the new pro-business President Sebastian Pinera, Chile now looks to have major growth potential, particularly during this period of high commodity prices. Chile's response to the earthquake and the miners' rescue demonstrates that, in contrast to most of Latin America, Chile is an open society where both public and private sectors function at a high standard. Buy.

• Colombia: Was recently included in the CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa) collection of emerging markets that are expected to follow the BRICs into rapid growth. (Chile is not a CIVETS, but even though it is still quite poor it can be regarded as a super-CIVETS, like say South Korea). The successful presidency of Javier Uribe overcame Colombia's guerilla problem, or at least lessened it, and set Colombia on a path of free-market growth. Under the new president Jose Santos those policies can be expected to continue. Colombia will additionally benefit if the new U.S. Congress ratifies the U.S.-Colombia Free Trade Agreement, signed in 2007 but held hostage by the protectionist Democrat majority. Also, like Chile, it has a huge bounty of natural resources, including major offshore oil deposits. Buy.

Actions To Take: When it comes to Latin American investing, let politics be your guide.

Several of the countries - including longtime "BRIC" darling Brazil - aren't as alluring as they once were.

However, the encouraging thing is that the two best countries - Chile and Colombia - are genuinely attractive investments; in fact, they can stand up to virtually any other market opportunity anywhere else in the world.