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Michael Fowlkes' Analyst Insights

Options and ETF Analyst Writer
Michael Fowlkes
Author Bio

September 09, 2013 - Playing it safe in Latin America

The last few months have been tough on Latin American markets, but the overall picture still remains positive. One of the biggest concerns over Latin America in the past has been political instability. According to Juan Pablo Cuevas, Bank of America Merrill Lynch's head of Global Transaction Services for Latin America, the region has shifted away from political instability and is now under the control of longer-term governments.

According to Bank of America's research, there are many of reasons why multi-national corporations consider Latin America to be a good place to expand their businesses. For one, real estate is cheaper in Latin America than in the U.S., and often times Europe or Asia as well.

Latin America is also benefitting from the economic problems occurring in many parts of Europe. High unemployment in countries such as Spain and Portugal has created a big opportunity for Latin American companies, which have been able to headhunt for top talent in a wide range of industries. The impact of bringing in talented workers from Europe should help Latin American companies continue to grow.

One reason why Latin American markets have been weak is fear over the impact that Federal Reserve tapering will have on the region. I believe that Fed tapering will have a minimal impact on the region, but the greater threat is the economic slowdown taking place in China.

The slowdown in China has had a negative impact on commodity prices, which play a vital role in several Latin American nations. Commodity prices will rebound, and when they do, these nations will experience some nice growth once again.

Latin America is rich in resources, and with gold and silver prices being as weak as they have been, the impact has been hard on its nations. Peru, for example, relies on gold and copper for half of its foreign shipments. The positive side of this is that lower commodity prices have reduced the risk of inflation across Latin America, which opens the door for additional monetary stimulus plans across the region.

According to the sixth edition of the UPS Business Monitor, Latin America, 70% of small and mid-sized businesses expect Latin America businesses to grow strongly over the next 12 months. Among the most attractive industries in Latin America are technology and construction. According to executives surveyed in the region, these two industries are poised for strong growth.

Based on the strong underlying fundamentals of Latin America on the whole, I would like to put a little money to work in the region, but due to the recent weakness in many of its markets, I would make sure that any investment would be highly diversified and hedged in case things do not improve as expected.

A good way to accomplish this is with a trade on the exchange-traded fund iShares S&P Latin America 40 Index (ILF). ILF tracks an index that comprises 40 of the largest Latin American equities, so you get a very diversified investment over a wide range of industries. 

A nice hedged trade on ILF is the March 27/31 bull put credit spread. In this trade you will sell the March 31 put, while buying the same number of March 27 puts for a credit of 45 cents. This trade has a target return of 12.7%, which is 23.5% on an annualized basis (for comparison purposes only). With ILF currently trading at $36.54, this trade has 13.9% downside protection.

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