Conclusion: Over the next few years, we expect investors to negatively reset their expectations for Peru’s long-term growth potential as a result of structurally higher inflation and interest rates (provided the central bank is allowed to remain independent). That’s bearish for Peruvian equities and we’ll look to short strength on rallies over the long-term TAIL absent a change in political strategies by new President Ollanta Humala.
Position: Short Peruvian Equities (EPU).
This afternoon, we added a short position in Peruvian equities to our Virtual Portfolio. We written extensively on our long-term outlook for Peru and are using today’s “strength” (Lima General up +13bps) to express our conviction in a core belief that Big Government Intervention (via a measured shift towards socialism in Peru’s case) is negative for the long-term health of any functioning economy. Simply put, we think newly elected President Ollanta Humala will grow increasingly motivated to over-tax the country’s vast mineral resource initiatives, as well as use pension funds and potentially FX reserves in an attempt to push his populist agenda.
Any attempts on Humala’s behalf to run the currency devaluation/overregulation strategies of his long-time mentor, President Hugo Chavez of Venezuela, and we’re likely to see a measured uptick in CPI in Peru over the long-term TAIL. That’s bullish for Peruvian interest rates and bearish for Peruvian growth, and we’d argue that the long-term expectations for both require an adjustment that is negative for Peruvian equities. Some would argue that the “Humala effect” is priced in with the Lima General down -13.4% YTD, but we firmly believe the process by which the market resets the aforementioned expectations will be one that plays out over the long-term TAIL.
Near-term, however (we prefer to keep our catalysts as close in duration as possible on the short side), we think Peruvian growth is slowing. In fact, Peru’s monthly Real GDP growth slowed to +0.47% MoM in May, good for the slowest pace in over a year and our models portend more downside from a YoY perspective for at least the next two quarters. From an inflation perspective, easy comps will supply upward pressure to Peru’s YoY CPI over the intermediate-term trend. Indeed, Peru is one of the few countries we model that won’t necessarily see the full benefit of our Deflating the Inflation thesis playing out in the commodity complex.
Net-net, we’re short Peru and the future socialism embedded therein. For more background on this thesis, please refer to our April 27 report titled: “Everyone’s a Winner – Except Peru”.