The year of the “black swans” has come to an end and with it the promise of recovering the much longed-for normality returns, as many investors don’t want strong emotions for a while. Latin American corporate debt has not been immune to the volatility of 2022, but is in a position of solid fundamentals, which leads us to believe that this year will be better.
The euphoria associated with the end of a pandemic that became eternal was suddenly interrupted by Russia’s invasion of Ukraine – the first large-scale conflict in Europe since the Second War – which provoked not just a tremendous social and humanitarian crisis, but also had a severe economic impact. Specifically, inflation shot up to levels not seen in the last 40 years, driven by the rise in commodity prices caused by the military conflict, while adding to the pressure on already stressed global supply chains.
Given that Russia is one of the world’s largest oil producers, the impact of the war and the corresponding sanctions imposed by the West drove crude oil prices up to over USD 100 during the second quarter, their highest in 15 years. Along these same lines, fertilizers, which Ukraine was a major producer of, chips for the automotive industry and gas in Europe also reached record prices. In this context, despite a hesitant start to its rate hike cycle, the Federal Reserve’s response definitively removed the “transitory” label from inflation and led the 10-year rate to rise 200 bps, while the two-year rate rose 350 bps, leaving the US Treasury bond curve inverted. In contrast, Covid has been receding as the focus of global fears, except for China, which maintained draconian lockdowns in the first part of the year, which together with regulatory noise in the tech industry caused Chinese stocks to fall by 15%.
Consequently, from the global perspective there were diverse extraordinary factors that drove Latin American bonds in US dollars to show their worst yields since the 2008 financial crisis, though they showed resilience compared to other asset classes, such as emerging fixed income (-22%), US shares (-20%) and even Treasury bonds (-15%). Within the asset class, the interest rate hike hit better credit quality bonds hardest, which have longer durations and less spread: while JPMorgan’s benchmark index for Latin American bonds fell 8%, the index restricted to investment grade and high yield papers fell 11% and 6% respectively.
From the regional perspective, 2022 has been marked by political movements. In Chile, the proposed new Constitution was rejected by a large majority, in Peru the ex-president Castillo was deposed and arrested, while Gustavo Petro and Luiz Inácio Lula da Silva won the presidential elections in Colombia and Brazil, respectively. However, the legislative branches in both countries - especially the Senates - have a strong presence of centralist parties, which would force candidates to moderate their proposals and reach consensus.
The assets that have suffered the impact of politics the most are those from Colombia, whose local currency depreciated 18% in the year, despite having clear positive catalysts such as being the country that grew the most in the region, favorable terms of trade thanks to oil prices, and a more market-friendly finance minister than had initially been expected. In this sense, Ecopetrol’s 2030 bonds fell by 18%, while those of its subsidiary Ocensa, a strategic pipeline, fell 12%, as did those of Bancolombia, the country’s largest bank.
In the case of Brazil, Lula’s return to power was partially incorporated into prices, as polls had indicated he would be the clear winner. While his term began on the first day of this year, the signs sent before his inauguration have not been encouraging, both because of the people appointed to key positions – such as Finance Minister Fernando Haddad – as well as the bills to increase fiscal spending that were already sent to Congress. However, companies’ financial strength, together with the positive impact of the commodities boom, strong growth in the domestic market as an alternative source of financing for companies, and the recent slowdown in inflation give us hope for stability in the region's largest economy, which could be accompanied by the start of a dovish cycle in domestic rates.
At the issuer level, the biggest drops in the year were observed in the bonds of Mexico's biggest real estate investment firm - Uno - whose long papers plummeted 30%, punished by negative headlines about its controllers and for maintaining high leverage despite operational improvements. It was followed by drops in longer Mexican corporate bonds like those of Coca-Cola bottler Femsa, the state-owned generation and transmission company Comisión Federal de Electricidad (CFE), the food producer Bimbo and telco América Móvil.
Among papers with the biggest spreads, Argentine corporate bonds performed the strongest in 2022, especially the state-owned oil company YPF, in a year of significant operational improvements, increase in guidance and an energy sector with incentives to export and the focus of investment despite record inflation. Certain provinces also stood out, along with the government utility Agusan and Aeropuertos Argentina 2000, where international traffic recovered strongly despite the currency’s depreciation. The Argentine government managed to sign a new agreement with the IMF and the Club of Paris earlier this year, allowing reserves to be accumulated in the Central Bank to cover gas imports during the winter, at historically high prices.
Defaults were controlled and less than initially expected, restricted to specific credit histories rather than generalized asset class factors. The worst performers were Mexican non-bank financial companies, with Crédito Real and Unifin falling into default. Beyond these names, stressed apers were also under a lot of pressure, like those of the telco Oi, despite the sale of assets during its restructuring process. Along the same lines, the Central American communications firm Digicel fell 50%, approaching a new restructuring due to the challenging short-term maturities it faces.
The primary market was closed to most issuers and around USD 40 bn were issued, about 50% less than the average of the last 10 years. With maturities, buybacks and tenders worth USD 64 bn, net supply of bonds contracted strongly in the region, reducing debt stock by 5%. It should be noted that the presence of sustainable and green bonds remains high, representing 30% of total issues.
We expect a considerably better year in 2023. On the one hand, the yield is high (9-10%) as a result of the negative performance in 2022 and the accrual will therefore be a positive factor, in a 2023 in which base rates are much closer to their peak and a good part of the increases are already reflected in the curve.
For its part, the political front next year looks clear, with presidential elections only in Argentina and where a change in course is strongly favored in the polls. For its part, Chile will face another constitutional process, but this time it seems to be marked by greater moderation and widely accepted foundations. Meanwhile, inflation is on track to being controlled in domestic economies, which creates room for local rate cuts by the end of the year, boosting economies and improving access to local financing for companies.
Though the region's growth will likely slow to 1.7%, it will be backed by the easing of restrictions in China, which gained strength in the final months of the year. In addition, defaults would be controlled and focused on the specific situations of stressed corporate bonds, with the rest of companies showing strong fundamentals. Thus, a recovery in the appetite for risk and inflows to the region can be expected, laying the groundwork for what we expect to be a very good 2023 for the asset class.
Regarding our position, we maintain a greater focus on high yield instruments, prioritizing Brazil and Mexico over the Andean region and betting on companies with solid fundamentals that allow us to capture good returns in the face of the imminent base rate correction.