US Yield Spike Creates Opportunities in Latin America
Latin American markets got creamed in the past month. The spike in the U.S. Treasury yields has had a negative knock-on effect for regional currencies, but there's a way to take advantage of the currencies' slide, says one fund manager.
On Wednesday, the Federal Reserve Chairman Ben Bernanke said the central bank may taper its bond buying program later this year if the economy continues improving. The markets read that as a sign of a more positive outlook for the U.S. economy, pushing up the dollar against emerging markets currencies and sending their stock markets tumbling.
With anticipation building that the Fed will start curtailing its stimulus program, investors expect the Mexican peso and Brazil's real to be hit, and those currencies have started to reflect that view, said Luiz Carvalho, a managing partner at long/short equity fund Tree Capital, which focuses on Latin America.
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But that creates opportunities to invest in companies that produce locally and export overseas as the crumbling currencies give them a competitive edge.
"As the Mexican peso loses value, the production sector benefits dramatically," said Carvalho.
The cost of the production, calculated in the local currency, is shrinking when expressed in dollars. However, revenue from the export comes in dollars, helping companies widen their margins, Carvalho noted.
Brazil's local industrials also get a margin boost from the weakening real.
Brazilian jet maker Embraer, for one, calculates the cost of engineering in reals and sells its jets in dollars to the international clients. Its stock gained more than 9 percent since the end of May when Bernanke first said that the Fed may reduce its monthly bond purchases.
Embraer is projected to report annual earnings of $3.02 billion—a 19-percent increase from last year—on revenue of $6.96 billion, according to Thomson Reuters estimates.
Another example, Carvalho said, is a Brazilian company Minerva, which sells meat on the global market and gets payments in dollars. For the full year, revenue is expected to jump 11 percent and earnings are expected to rise 55 percent, according to Thomson Reuters.
Brazilian and other emerging markets' stocks continue to be volatile, though this volatility is "not unheard of," BlackRock's portfolio manager Rodolfo Martell told CNBC. He said the emerging markets saw similar volatility in May 2012 and in the fall of 2011.
Even taking into consideration the latest outflow, emerging markets have seen inflows of $10 billion this year, said Martell, whose investment company has $250 billion under management in emerging markets.
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Martell remains positive on emerging markets in the medium and long term, though he said merging markets could see more capital outflow in the near future.
"There is still some room for things to get worse before they get better," he said.
With U.S. yields on the rise and investors selling emerging market stocks, regional currencies may continue to slide.
"The Latin American currencies are reacting to the change in the outlook for interest rates in the U.S.," said Tree Capital's Carvalho.
As of Monday, the U.S. benchmark 10-year Treasury yield was at 2.624 percent, an enormous spike. Latin American rates have to rise and currencies have to adjust, he said. Carvalho expects these currencies to keep sliding in the short term.
"The outlook is going to be very volatile, probably the currencies will be very week, until the Treasurys market stabilizes," he said.
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