Will Flanders at Merrill Lynch examines the implications for investors of the recent presidential election in Mexico and the forthcoming election in Brazil.
Latin America has had a heavy election calendar in 2006, with more than eight countries in the region (including heavyweights Mexico and Brazil) electing presidents this year. It is testament to the region's new-found economic stability that markets have been able to digest this heavy schedule and continue to focus on the positive prospects for the main Latin American economies.
The presidential polls in Mexico on 2 July may turn out to be the country's closest-ever presidential race. Centre-right National Action Party (PAN) candidate Felipe Calderon initially appeared to have won by around 400,000 votes. However, this lead subsequently narrowed, prompting a manual recount.
After several days of uncertainty, Mexico's Federal Electoral Institute (IFE) on 7 July announced that Calderon had won by fewer than 250,000 votes, only just ahead of his main rival, Democratic Revolutionary Party (PRD) candidate Andres Manuel Lopez Obrador. Lopez Obrador has alleged electoral fraud and vowed to challenge the results.
Previous Mexican polls have been overshadowed by claims of vote-rigging and Lopez Obrador, who is Mexico City's populist mayor, is good at stirring up a crowd. Lopez Obrador may create plenty of political noise over the next few weeks before the results are finally confirmed by 6 September at the latest. We may see some market volatility as a result, but there is no indication at this stage that Mexico's stable democracy cannot weather this temporary storm.
Lopez Obrador had been viewed as potentially non-market friendly and Mexico's markets rallied strongly on the news of Calderon's victory. Nevertheless, Mexico's Congress and Senate will remain divided across the three main political parties, the PAN, the PRD and the Institutional Revolutionary Party (PRI), with the PAN and the PRD both surpassing the PRI, formerly the largest party in both houses.
The expected political gridlock that we anticipate will continue in the legislative branch leaves us sceptical that much-needed reforms (energy, labour and political) will be forthcoming soon, especially given the tight vote and the lack of a clear mandate for the president-elect.
Against this backdrop, we still view the election result as a positive for Mexico's economy, as it continues to make impressive strides. Strong oil revenues have boosted government revenues and the country now boasts an impressive trade surplus and current account surplus, while annual inflation is now down to around the 3% mark. Equity valuations overall are close to fair value, but we continue to find many interesting equity stories to invest in Mexico.
The next key date on the regional political agenda is presidential elections in Brazil on 1 October. If none of the presidential candidates gain more than 50% of the vote, there will be a second round of voting on 29 October with the top two vote winners.
President Lula da Silva currently looks likely to secure his second term in office, possibly in the first round, with Social Democracy Party (PSDB) candidate Geraldo Alckmin in second place. Markets responded very negatively to Lula's election four years ago because of perceptions that he would take Brazil radically to the left.
However, markets have been pleasantly surprised by Lula's decision to stick with sound fiscal policies which, together with the Central Bank's strict, inflation-targeting monetary policy, have left Brazil on course to achieve investment grade status by as early as 2008.
We see no reason to expect a change in these policies if Lula were to win a second term. On the other hand, if the PSDB were to regain the presidency, we would expect a faster rerating of equities as the stalled reform process aimed at improving Brazil's global competitiveness would get a boost and become a priority