The Eastern Pacific countries in which Pacific Wealth invests – primarily Mexico, Colombia, Peru and Chile – have had a miserable 2015. They all depend heavily on commodity and energy exports, and commodity and energy prices have sunk like a rock. The Thomson Reuters Core Commodity Index of commodity and energy prices dropped 34% in the last year.

Still, commodity prices may be bottoming out and all four countries have received an enormous hidden benefit in the decline of their currencies against the dollar. So at least for exporting companies the next year looks considerably better than the last one, and we should over time expand our holdings in this area.

The declines in Eastern Pacific currencies against the dollar have almost equaled the decline in commodity prices, with the Mexican peso down 23%, the Colombian peso down 42%, the Peruvian sol down 14% and the Chilean peso down 17%.

So in local currency terms, important because they determine production costs, commodity prices in general have declined only modestly, and have indeed risen in Colombian peso terms. Eastern Pacific countries’ budgets have been destabilized, because of the loss of commodity-related revenues and the dollar costs of manufactured goods and services imports have dented their balance of payments, but their core commodity production operations have not dived into loss.

Better Run Countries

Eastern Pacific countries, such as Brazil, Venezuela and Argentina, are generally better run than their neighbors without Pacific access. For example, even though the Latin American countries have been more or less equally affected by declining commodity prices, projected Eastern Pacific budget deficits for 2015, according to the Economist forecast team, range from 0.4% of GDP in Peru to 3.4% of GDP in Mexico, compared with 3.3% of GDP in Argentina (almost certainly a “cooked” statistic) 5.8% of GDP in Brazil and an untenable 16.5% of GDP in Venezuela. 

Their current account positions are less stellar – Colombia’s 6.6% of GDP, badly affected by falling oil prices, is especially concerning – but here they benefit from better behavior in the past. All four countries have fairly low international debts and are rated investment grade by Moody’s and Standard and Poor’s, so they can tap the international bond markets to cover temporary deficits while waiting for their devaluations to boost exports and reduce imports. Most important, none of the four countries is in recession, or anywhere close to it.

Those are far better than most of Latin America and reflect these countries’ sound pro-market policies. The four are linked in a Pacific Alliance trade pact, which is notably more pro-market and pro-trade than the southern Latin American countries’ Mercosur. Their growth is in contrast to Brazil’s performance, where second quarter GDP was 2.6% below the previous year, a result of a decade of big spending and state meddling.

While the commodities decline has been continuing, the Pacific Alliance countries have been poor investments. Macro-economically, they have been dealing with the shock of lower prices for their commodities, resulting in budget strains that have been especially severe in oil-dependent Mexico and Colombia.

Furthermore, U.S. investors have seen erosion in the principal value of their holdings, even as local stock markets have not been particularly weak, as the erosion in local currency values against the dollar have reduced the dollar value of holdings. In our Pacific Wealth portfolio, which has been underweight in this region, the value of our Bancolombia S.A. (NYSE:CIB) holding has declined since we bought it, mostly because of the weakness of the Colombian peso.

China Still Growing

There are a number of reasons why this may be about to turn around. Among them: Chinese growth has not ceased, but Chinese inventories of such items as copper have declined sharply. Oil prices are likely to rise in the year ahead.

The Pacific Alliance countries have kept inflation and their budget deficits under control, so their non-commodity exports have become far more competitive as their exchange rates have declined and there is little danger of an inflationary slump, as is occurring in Brazil.

To take advantage of the likely turnaround in Pacific Alliance countries’ stock prices, we need to look for stocks that will especially benefit from the region’s lower currency values. We thus need to look for exporters, ideally selling into the U.S. market. Companies competing primarily in the domestic markets will benefit less directly, while those companies such as retailers that rely primarily on supplying imported goods to domestic consumers will be badly hurt, as consumers’ purchasing power has declined in dollar terms.

Of course, energy and mineral exporters may also be of interest; Pacific Wealth currently has two of those, the Australia-based Rio Tinto PLC (NYSE: RIO) and the Philippine geothermal company Energy Development (OTC: EGDCY).

Industrias Bachoco S.a.b. de C.V., (NYSE: IBA), the Mexican poultry producer, certainly fits our criteria for a holding that can take advantage of its weak currency domicile. Its production costs in Mexico have benefited by the peso’s decline against the dollar, which have made it much more competitive against U.S. competitors both in the U.S. market and in its domestic market.

You can see the effect clearly in its second quarter results: sales were up 12% from the previous year, with volume up 11%, and net income up 28%. U.S. sales represented 23% of the total, up from 20% in the previous year.

Bancolombia S.A. (NYSE: CIB), the largest bank in Colombia, is not in general a beneficiary of the Colombian peso’s decline, because it will have made its capital worth less in dollar terms, thus stretching its leverage since many of its loans are in dollars.

Nevertheless the bank’s position in its domestic market, and Colombia’s continued solid growth and good management, make it a valuable core holding, especially as it is trading on only 8 times market estimates for 2016 earnings with a yield, based on its last peso dividend, of 3.9%.

Over time, I will be looking for opportunities to add to the Eastern Pacific holdings in our Pacific Wealth portfolios.