NEW YORK — Investors seeking opportunities in Latin America may do well if they bet on the prospects of Brazil and Chilean markets. Analysts of New York-based investment bank Morgan Stanley favor companies in both countries that could outperform the rest of peers in the region, according to a report by six analysts on the firm.

Brazil and Chile’s stock markets seems “attractively valued” and would deliver as part of the so-called “global reflation trade,” analysts Guilherme Paiva, Cesar Medina, Juan P. Ayala, Nikolaj Lippmann, Julia L. Nogueira and Lucy Beauvallet, write in a 91-page report dated August 26.

“We are overweight Brazil and Chile (global reflation trade). Meanwhile, we are neutral in Colombia (social unrest, potential higher taxes), and underweight Mexico, Peru and Argentina (asymmetric political and macro-economic risks),” the analysts said in the report. As a whole, Latin American equities are trading at close to 10.0x forward earnings estimates, or -0.9 S.D., below their 18-year historical average.

Morgan Stanley’s market recommendation is also based on a recovery in the price of commodities, a key component in the exports of most Latin American nations. “We like both commodity and selective domestic cyclical stocks to gain exposure to the ongoing global reflation trade and a potential 2H21 regional economic recovery,” the analysts said. “At the sector level, in our Latam Model Portfolio, our preference is for materials, industrials, energy and real estate.”

The short-term outlook for the U.S. economy, taking into consideration aspects such as job market and inflation, “should influence the Fed decision about when to taper and lift off rates, and thus impact crude oil, grains, iron ore, proteins, pulp and steel prices,” analysts said in the report. Latin American governments should be able to implement a “sustainable economic reopening in 2H21” depending on the local pace of vaccination against the Covid-19 virus.

At the same time the bank warns of potential risks as several Latin American countries will deal with relevant political elections over the next 18 months, “which could skew the risk reward equation to the downside.” Argentina has mid-term elections in November, with a primary in September; Chile celebrates presidential elections in November, Colombia in May 2022 and Brazil in October 2022.

In Brazil, Morgan Stanley likes sectors and stocks which provide exposure to global cyclical growth and domestic secular growth stories. As Top Stock Ideas, the analysts favor XP, PagSeguro, Gerdau, Itau, Vale, BTG Pactual and state-owned oil conglomerate Petrobras.

Meanwhile, in Chile, “government fiscal support and saved funds from 3 rounds of pension fund withdrawals, together with an efficient vaccination program, should help the local economy recovery swiftly.”

The analysts have a mid-2022 target for the MSCI Latam index of 2,700 points, or ~14% return on U.S. dollars from current levels. Since its inception on December 1st, 2009, Morgan Stanley’s model portfolio has returned 11.1% vs the MSCI Latin America index -18.4%, an outperformance ~3,630bps during the period, the bank said in the report.

Underweight

Asymmetric and macroeconomic risks put “underweight” rating on Mexico, Argentina and Peru. In the case of Mexico, Latin America’s second-largest economy, “we do not see an end to the current investment limbo in the near future.” Persistent fiscal deficits and macro policy risks in Argentina “limit our exposure,” the analysts conclude.

The analysts believe that the ongoing high macro policy uncertainty in Peru, “should continue as the Castillo administration pursues a Constitutional reform process.”

In Colombia, higher energy prices resulting from a global reflation trade should continue to limit further public sector fiscal deterioration and support the economic activity in the Andean nation. However, “political uncertainty ahead of the May 2022 Presidential election and higher corporate income tax rate are a drag to investment sentiment,” the report said.

The analysts said they would avoid sectors such as food, steel, transportation and information technologies in the case of Brazil, as well as airports, banks & financials, telecom and food and beverage.