What happened to the Latin American market contagion that investors and analysts feared would happen this year? As Argentina suffers a continuing financial and political crisis, several other Latin American markets have strengthened.
It may be too early to know for sure, but the early signs suggest that Latin American stock, bond and currency markets may be in the early stages of a new dynamic in which investors differentiate more between the region's countries. The crisis in Argentina hasn't sparked a regional meltdown.
In the wake of the Mexican peso crisis of 1994 and the Asian and Russian crises of 1997 and 1998, all of Latin America's markets suffered together. The conventional wisdom was that a major crisis in one developing nation was supposed to be bad news for all developing nations, since they depend on the same group of investors from industrialized countries for the bulk of their financing.
Yet Argentina's crisis hasn't had this effect so far. Now investors are more experienced in the topsy-turvy markets of developing nations and perhaps less likely to dump their investments and bolt at the sight of trouble.
How else to explain recent stock-market strength in Mexico, Peru and Chile, a switch from rallying to sinking in Venezuelan bonds, and price increases for bonds from Peru and Brazil? All of this happens as Argentina heads toward what looks to be one of the biggest sovereign debt defaults ever. A global economic slowdown, low commodities prices, and less international investment in developing nations have worsened the situation.
The traditional argument for the relative calmness of the region's markets in the face of such stress is the lack of leverage. When Mexico devalued its peso in 1994 and even more so during the Asian and Russian financial crises of 1997 and 1998, some investors, especially hedge funds, had huge leveraged bets on the same assets. When Russia melted down, for example, these investors couldn't sell their Russian bonds fast enough and many were caught at the exit. This is what led to the demise of the infamous Long Term Capital Management (LTCM) under billions of dollars in leveraged bets gone bad.
So investors like LTCM sold other more liquid emerging market assets to cover the margin loans on their leveraged Russian and Asian bets. The word today is that there isn't nearly as much leverage in the markets as just three years ago. That's one part of the explanation.
Something else, more profound, may be happening in Brazil: investors may be getting more savvy about emerging markets, learning to distinguish between them, and finding that it may be better to sit and wait than immediately rush for the door, even during a huge crisis.
"You don't have hedge funds who are over-leveraged and you have not had a lot of panic selling yet," says Christian Stracke, head of Latin America fixed-income strategy at Commerzbank Capital Markets. "Perhaps investors have learned from 1998 that you don't want to sell out at the bottom of the market," he explains.
This is why talk of regional contagion because of Argentina's problems sounds off-key these days. Investors appear to be judging countries on their merits more than on what is happening to their neighbors. So while Brazil may have suffered from Argentina's crisis and is now rallying, it remains vulnerable to a different list of challenges particular to Brazil, such as presidential elections slated for next year.
This is not to say that the region as a whole doesn't suffer when the US economy slows or when capital flows drop to developing nations in general, both of which have occurred. The IMF reported two weeks ago that capital flows to Latin America through the end of last month dropped to US$41 billion from a total of US$69 billion for all of last year.
As long as Latin America has low savings rates, it will remain highly dependent on foreign capital flows. Yet it is becoming increasingly clear that some countries stand to get proportionally more foreign capital flows than others during tough moments. After about a decade of initiatives to open economies to new investment and trade, it has become clear that some countries have done better than others.
This is part of the reason why Mexico's stock, bond and currency markets have maintained their strength despite the Argentine crisis and the slowdown in capital flows. Not that Mexico won't suffer at some point, though perhaps not nearly as much as in the past. Nobody is yet predicting another Mexican crisis anytime soon.
The same goes for Chile, where the main stock index has risen about 21 percent since Oct. 8 while the currency has strengthened 6.5 percent against the US dollar.
Brazilian stock, bond and currency markets have rallied over the last few weeks with the real rising 12 percent against the dollar since Oct. 8. Brazilian markets are likely to suffer again if the situation in Argentina deteriorates markedly. Yet investors figure Brazil has taken enough of a beating for the moment.
Investors in Latin America still have plenty of things to be concerned about. Financial contagion might not have to be one of them.
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