Latin America

There’s more to Peru than Machu Picchu

My first trip to Peru was in 2001. I had flown from La Paz in Bolivia to Cusco in Peru, the old capital of the Incan empire. From there it’s a four day hike on the Inca trail, or a few hours on the train, to the famous ruins of Machu Picchu – the Incas’ hidden mountain settlement. But for investors, there’s a lot more to Peru than Machu Picchu.

Peru was one of the territories invaded by the Spanish conquistadores in the 16th century. Spain ruled from 1533 to 1821, when Peru gained independence. Since 1980 it has been a democracy and the economy has really picked up over the past decade.

In fact real (inflation adjusted) economic growth has averaged 6.4% a year since 2002. In 2012 it was 6%. The government runs a budget surplus of 0.9% of GDP, meaning it spends less than it receives (a big difference to most developed countries).

As a result public debt is a low 18% of GDP, again far from the elevated levels seen in developed countries. That’s not as low as the 12% in nearby Chile, or 8% in further away Russia. But it’s still very low by global standards.

In the last 10 years the nuevo sol has gained 29% against the US dollar.

This helps explain the strong currency in Peru, the nuevo sol (literally “new sun”). In the last 10 years the nuevo sol has gained 29% against the US dollar. This is despite a recent sentiment-driven sell off in emerging market stocks, bonds and currencies (which has nothing to do with conditions in Peru). In fact the nuevo sol was up 39% against the dollar, since July 2002, as recently as January this year. But taking where we are now, 29% over ten years works out as 2.6% average compound annual gain against the dollar.

(You can find an explanation of compounding in chapter 2 of our Wealth Workout special report that you can download here.)

Peru is the 20th largest country in the world, and has a population of nearly 30 million people. That population is young too: 47% are under the age of 25 and only 14% are over 55. This means there are lots of young people set to come into the workplace and help grow the economy in future.

Price inflation seems well under control. The target is for it to fall in the range between 1% and 3%. During 2012 it was 3.6%, and is expected to be below 1% this year. It’s in the ballpark in other words.

Peru is an important mining country, and one of the leaders in the production of various important base materials.

Peru is an important mining country, and one of the leaders in the production of various important base materials. It’s first in the world for silver, third for copper, zinc and tin and fourth for lead and molybdenum (which is mainly used to produce high strength steel alloys).

There’s more to Peru than Machu Picchu

MSCI defines Peru as an “emerging market”. The other four within Latin America are Brazil (Brasil), Chile, Colombia and Mexico. Overall there are 23 markets in the world that MSCI defines in this category (most recently including Greece, which was demoted from the developed markets earlier this year).

According to the Financial Times, the Peruvian stock market has a P/E ratio of 11.8 and a dividend yield of 3.9%. This makes it the cheapest it has been for some time, relative to earnings. As recently as the end of March 2012 the P/E was around 39.

Since then the local stock index has fallen by 37% and earnings have grown strongly. In addition the currency, the nuevo sol, has fallen 3.8% against the dollar. Taken together this means the market is down 40% in dollar terms. It’s now looking like pretty good value.

Of course it could keep falling from here if global investor sentiment, which is dominated by crowds of fund managers in developed countries, stays negative towards emerging markets. But from these levels the long term outlook is likely to be rewarding for investors.

Growth is more likely to average in the high single digits, taking returns to the 12% to 14% range.

After all, if the P/E doesn’t change at all then expected returns can be estimated by adding the dividend yield to the earnings growth. With a yield of 3.8% we only need 6.2% a year of growth to reach double digits, or 10% a year. Growth is more likely to average in the high single digits, taking returns to the 12% to 14% range.

And don’t forget, that’s assuming the P/E ratio stays at its current low level. Any increase over time would give an additional boost to profits, potentially taking returns into the high teens on average, over say a five year period.

One easy way to invest in Peruvian stocks (shares) with an ETF is by buying the iShares MSCI All Peru Capped Index Fund (NYSE:EPU). An ETF is an “exchange traded fund” which trades like a single normal share. But it’s a share in a fund that owns a range of underlying shares or other assets.

At the time of writing EPU has a P/E of 13.9 and a dividend yield of 3.9%. The market could have further to fall in the short run, with global sentiment towards “risk” assets as weak as it is. And stock prices in countries like Peru can be highly volatile at times.

But Peru is definitely a stock market that we’ll be watching here at OfWealth, as we think it could reward long term investors with handsome profits. I encourage you to keep an eye on it too.

Until next time OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.