Global Perspectives Weekly

Latin America: Watching the Rally MAY 14, 2014

In this Global Perspectives Weekly:

Sean Lynch, CFA® Global Investment Strategist Peter Donisanu Global Research Analyst

Government Structural Reforms » Latin American equities have quietly rallied in recent months as market observers appear focused on developments in other parts of the world. » Markets may be pricing in expectations about regional structural reforms and Brazil’s elections; however, leaders in these countries have a lot of work ahead of them. » We are waiting for concrete signs that structural reforms are taking effect in Brazil and Mexico. For now, we are maintaining our neutral recommendation on Latin America.

Recent asset price appreciation in Latin America has come about with little fanfare as market observers have focused on headline events in the Eurozone and Ukraine, and uncertainty about China’s economic growth prospects, Latin American markets have stealthily climbed in value, most notably since their mid-March lows. After following regional developments for the past few months, we are beginning to observe an indication of a return of investor confidence towards Latin America—reflected in strong equity and currency market appreciation. Nevertheless, we view the rally as tentative and continue to watch for long-term themes in the region to take root. Until then, we maintain our neutral tactical recommendation on several Latin American countries, including Brazil, Mexico, Chile, and Peru. Chart 1: MSCI Latin America country weights and performance (Percent) Country

MSCI Weight

1 Week

1 Month

March 14, 2014

YTD

MSCI Latin America

100

0.5

1.9

17.7

3.9

Brazil

57.6

0.1

2.4

23.1

7.5

Mexico

26.1

1.3

1.7

10.6

-3.1

Chile

8.1

-0.3

-1.0

10.3

-0.7

Colombia

5.8

1.9

2.1

13.5

7.1

Peru

2.4

1.3

1.4

10.2

11.4

Source: Wells Fargo Wealth Management; FactSet, 5/9/2014

Stealth rally: two key players – When considering performance of the broader equity markets in Latin America, our preferred benchmark is the MSCI Emerging Markets Latin America index (MSCI LatAm). The index’s membership includes Brazil, Mexico, Chile, Colombia, and Peru. From a country perspective, the weighting of the index is biased towards Brazil which makes up 57 percent of the total index. When we combine Brazil’s weighting with Mexico’s contribution (26 percent) to the index, we see that these two countries drive much of the index’s performance. 1

Global Perspectives Weekly The LatAm index has increased over 18 percent from its March low, outperforming the broader emerging markets index, which has been up nearly eight percent during the same period of time. Moreover, currencies in the region have also appreciated, reflecting their foreign demand. In the near term we anticipate a few volatile yet supportive factors that could provide a tailwind for the short-term rally in the Brazilian and Mexican equity markets. These include momentum of expanding domestic energy-market reform and presidential elections in Brazil. Support of longer-term themes – Last year Mexican President Peña Nieto introduced a number of landmark public sector reforms, including opening up state-run oil giant PEMEX to private sector participation. Markets initially sparked an optimism rally in response to the news, but then appeared to begin pricing in the potential for political gridlock and the challenges of working technical legislation through congress. Nevertheless, in April the government sent a legislative package to Mexico’s congress that is widely anticipated to pass. The proposed legislation outlines specific policies for private sector participation and details how PEMEX would maintain control of national interests. Meanwhile, in Brazil, optimism over last October’s deal orchestrated by policymakers to open up the Libra oil field—a large deep-water oil field off the coast of Rio de Janeiro—to foreign investment ultimately waned as investor bids fell flat. This weak turnout reflected, in part, uncertainty about the challenges facing smaller operators of exploration and extraction rigs and logistics service providers involving infrastructure and financing. In April, BNDES (Brazilian Development Bank), one of the largest single shareholders of Petrobras (Brazil’s state-owned energy corporation), announced a funding program that may benefit the energy sector. In this program, BNDES could offer up to three billion Brazilian reais in pre-IPO private capital funding to small-and medium-sized businesses, namely those smaller operators strategically positioned to support Brazil’s energy sector.

Index (12/30/2013 = 100)

FX (12/30/2013 = 100)

Chart 2: Brazil and Mexico – strengthening equities and currencies 110

BRLUSD (Real)

MXNUSD (Peso)

USD Weakness

105 100 95

USD Strength

90 110 105 100 95 90 85 80 75

Bovespa (Brazil)

Bolsa (Mexico)

Source: Wells Fargo Wealth Management; Bloomberg, 5/9/14

Finally, Brazil’s President Dilma Rousseff is up for re-election later this year. Voters and international investors alike welcomed Ms. Rouseff’s victory with optimism at the beginning of her first term; however, the president’s popularity has waned. Her support of overly optimistic social and fiscal policies appears disconnected from the challenging realities of implementing these programs effectively. 2

Global Perspectives Weekly Our View – One question that we have been struggling with is whether the worst is over for Latin America in the near and intermediate term. While we are watching the near-term developments in these markets with interest, a number of questions about local policies remain unanswered. One potential supportive factor for each of these markets, especially Brazil, is the potential for long-term energy production. Nevertheless, challenges to implement effective policy reforms remain. Last week a report released by the Baker Institute at Rice University 1 stressed the challenges that Nieto faces in his efforts to administer reforms in the country’s energy sector. The report highlighted the extent of outright theft, public official corruption, and drug cartel influence, namely the Zeta’s, on the country’s oil industry. While the liberalization of PEMEX has been enthusiastically received locally, international investors are keenly aware that this is not an easy endeavor. There are questions about how Nieto will address the issues of corruption, theft, and influence of drug cartels in his effort to establish public sector entities. Nieto has indicated that his administration will focus on addressing government corruption and drug-related violence, but these efforts may take time to implement as well. As for Brazil’s energy sector, the significance of BNDES funding comes at a time when credit at the national level has been drying up as the country’s economy enters the downturn of its credit cycle. Typically during a contraction of credit, small- and mid-sized companies find it difficult to obtain credit. This could be reflective in the lukewarm reception of the Libra deal given concerns over how smaller operators could keep up with expansion of the Libra fields. BNDES-backed access to credit for smaller companies, specifically within the energy sector, could provide the momentum needed to effect policy changes. Lastly, while Ms. Rousseff’s original campaign promise during her first term was to continue supporting the economic growth policies of her predecessor, President Luiz Inacio Lula da Silva, the economy subsequently floundered. One could argue that Brazil’s present economic woes may be attributed to a culmination of slowing in China’s economy, the U.S. financial crisis, and the Eurozone’s debt crisis. However, Ms. Rousseff’s Ministry of Finance has not been able to craft a consistent finance policy, resulting in uncertainty about taxation and corporate investment. Last month, Valor Economico, a local Brazilian newspaper, indicated that Ms. Rousseff was planning to replace present finance minister Alexander Tombini with current central bank chief Guido Mantega. The move to shift her cabinet is dependent on what happens in the economy, and more importantly, how Ms. Rousseff is doing in the electoral polls this year. Regardless of who Ms. Rousseff chooses to replace, her standing in the pre-election polls continues to fall. We believe the markets may be positively anticipating a post-Rousseff administration after October’s elections. Investment implications – Near term we are seeing signs of investor interest returning to Latin American financial markets, namely the stock markets of Brazil and Mexico. Appreciation in equity prices could be supported at the domestic level by a number of highly anticipated events, including policy reform and the upcoming elections in Brazil. Further, international participation in these markets has grown recently, as exhibited in positive investment fund flows during 2014. We find the near-term developments in these two countries, interesting, but we are maintaining our present view of holding neutral from a tactical perspective for now. While the near-term equity rally has been impressive, we continue to wait for clarity around a number of long-term questions before considering increasing allocations to Latin America.

1

“Energy reform and security in northeast Mexico”, Rice University Baker Institute, 5/6/14

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Global Perspectives Weekly Weekly Capital Markets Activity (5/2/14 – 5/9/14) Global Equity Markets MSCI All Country MSCI EAFE DAX (Germany) CAC 40 (France) FTSE 100 (UK) FTSE MIB (Italy) IBEX 35 (Spain) Nikkei (Japan) MSCI EM Shanghai SE (China) BSE 100 (India) KOSPI (South Korea) BOVESPA (Brazil) Mexico IPC

Wk -0.3% -0.5% 0.3% 0.4% -0.1% -1.8% 0.1% -1.8% 0.4% -0.8% 2.6% -0.1% 0.2% 1.6%

MTD -0.1% -0.2% -0.2% -0.2% 0.5% -1.8% 0.3% -0.7% 1.2% -0.8% 2.6% -0.3% 2.9% 2.3%

YTD 1.5% 1.0% 0.3% 4.7% 1.2% 12.8% 5.9% -12.8% 0.5% -4.1% 8.8% -2.7% 3.1% -3.1%

Global Sovereign Bond Market

Commodity Prices

Italy Spain France Germany Greece Portugal UK US Japan India

Energy Brent Crude Oil $/bbl Natural Gas $/MMBtu Agriculture Corn $/bushel Soybean $/bushel Precious Metals Gold Spot $/oz Silver Spot $/oz Industrial Metals LME Aluminum $/Mt LME Copper $/Mt Livestock Lean Hogs $/lb Live Cattle $/lb

Yield Wk Chg (BPS) 2.95 -8.9 2.92 -6.0 1.90 -2.7 1.46 0.6 6.04 -3.4 3.54 -8.6 2.69 4.3 2.62 3.9 0.61 -0.3 8.75 -6.0

Mexico IPC BOVESPA (Brazil) KOSPI (South Korea) BSE 100 (India) Shanghai SE (China) MSCI EM Nikkei (Japan) IBEX 35 (Spain) FTSE MIB (Italy) FTSE 100 (UK) CAC 40 (France) DAX (Germany) MSCI EAFE MSCI All Country

0%

2%

One Week Change: 05/02/14 - 05/09/14

BRL

CNY

AUD

CAD

CHF

GBP

EUR

1.38 17.82 82.72 3.04

8.61

1.47

1.50

1.22

0.82 140.1

JPY

0.01

0.06

1.05

0.01

0.87

0.58

0.71

JPY

0.4%

GBP

1.69 21.82 101.3 3.74 10.49 1.80

1.84

1.49

171.6 1.22

GBP

-0.1% -0.6% -0.2% -0.2% -0.6% -1.1% -0.8% 0.8%

1.23

0.67 114.9 0.82

CHF

-0.9% -1.5% -0.8% -1.0% -1.4% -1.8% -1.6%

0.81

0.54 93.47 0.67

CAD

0.7%

0.2%

1.0%

0.4%

0.2% -0.2%

1.02

0.83

0.56 95.36 0.68

AUD

0.9%

0.4%

1.0%

0.5%

0.4%

0.18

0.14

0.10 16.36 0.12

CNY

0.5%

0%

0.3%

0.1%

0.13

INR

Livestock 0.7%

Currency Table (Change in Pairs)

Cross rate as of 05/09/14 MXN

Ag -0.6%

Gra phi c repres ents the a vera ge s ector wei ghts of the S&P GSCI, Rogers Interna ti ona l Commodi ty, a nd Dow-Jones UBS Commodi ty i ndi ces a s of 05/09/14. Energy – 49%; Agri cul ture – 26%; Preci ous Meta l s – 12%; Indus tri a l Meta l s – 9%; Li ves tock – 4%. Da ta i n thi s gra phi c repres ents the one-week cha nge i n s ector pri ce a ccordi ng to thei r res pecti ve DJ-UBS s ubi ndi ces .

4%

Currency Table (Pairs) USD

PrecMet -1.4%

IndustMet 1.1%

Energy -1.4%

-2%

0.59

0.02

CHF

1.13 14.60 67.90 2.50

7.03

1.21

CAD

0.92 11.88 55.43 2.03

5.71

0.98

AUD

0.94 12.12 56.25 2.07

5.83

CNY

0.16

2.08

9.64

BRL

0.43

5.85 27.03

INR

0.02

0.22

MXN

0.08

USD

0.36

0.17

JPY

EUR

USD EUR

MXN

INR

0.0%

0.1%

2.81

0.48

0.49

0.40

0.27 46.02 0.33

BRL

-4.2% -0.1% 0.0%

0.10

0.02

0.02

0.01

0.01

1.70

0.01

INR

0.3% -0.5%

0.17

0.48

0.08

0.08

0.07

0.05

7.86

0.06

MXN

12.95 60.03 2.31

6.23

1.07

1.09

0.89

0.59 101.9 0.73

USD

Thi s ta bl e repres ents a cros s -currency pa i r i n a ma tri x forma t. The col umn on the l eft denotes the l oca l currency a nd the row a t the top of the ta bl e the forei gn currency. For exa mpl e, i f the l oca l currency i s EUR (euro) a nd the forei gn currency i s USD (U.S. dol l a r), then 1 euro buys $1.38 U.S. dol l a rs (a s of 05/09/14).

BRL

CNY

AUD

CAD

CHF

GBP

JPY

EUR

-0.8% -1.3% -0.8% 1.0% -0.7% -1.7% -1.5% 0.1% -0.7% -1.2%

0.04 4.62

WK -1.4% -0.6% -3.1% -0.6% 1.6% 1.1% -1.4% -0.8% -1.7% 1.1% -1.4% 0.6% 0.7% -1.7% 0.0%

Commodities

Headline Equity Markets One-week Change

-4%

Price -$107.9 $4.53 -$5.08 $14.87 -$1,289 $19.17 -$1,718 $6,796 -$1.20 $1.38

0.5%

0.2%

0.0% -0.1% -0.5% -0.4% 1.3%

0.5%

1.1% -0.5% 0.7%

-0.8% -1.3% -0.1% 1.6%

0.8%

0.3%

1.8%

1.0%

0.6%

1.7%

-0.4% -0.2% 1.5%

0.6%

0.1%

1.3%

0.2%

1.5%

-0.1% -0.6% -0.4% 1.5%

0.6%

0.0%

1.2%

0.0% -0.3% -1.1% -0.5% 1.4%

0.0%

0.0%

1.2%

0.1%

0.7%

0.2%

1.3%

0.0% -0.4% -0.1% 1.5%

-0.5% -0.2% 4.2% -0.5% -0.9% -0.7% 1.0%

0.1% -0.3% 0.8%

Thi s ta bl e repres ents the one-week cha nge for a gi ven cros s -currency pa i r. A pos i ti ve va l ue i ndi ca tes tha t a l oca l currency ha s a ppreci a ted (or you ca n buy more of a gi ven forei gn currency). The i nvers e i s true for a nega ti ve va l ue.

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Global Perspectives Weekly All data in this Global Perspective Weekly was sourced from Bloomberg unless otherwise noted. Disclosures Wells Fargo Wealth Management, a business division of Wells Fargo & Company, provides products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries. This report is made available in the United States only by Wells Fargo Wealth Management a business division of Wells Fargo Bank N.A. Wells Fargo Wealth Management takes full responsibility for the distribution of the report. Any unauthorized use, duplication, redistribution or disclosure of this report is prohibited. The information and opinions in this report were prepared by the investment management division within Wells Fargo Wealth Management. Information and opinions have been obtained or derived from sources we consider reliable, but we cannot guarantee their accuracy or completeness. Opinions represent Wells Fargo Wealth Management’s opinion as of the date of this report and are for general information purposes only. Wells Fargo Wealth Management does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. Past performance does not indicate future results. The value or income associated with a security may fluctuate. There is always the potential for loss as well as gain. Investments discussed in this report are not insured by the Federal Deposit Insurance Corporation or any other government agency and may be unsuitable for some investors depending on their specific investment objectives and financial position. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Your individual allocation may be different than the strategic long-term allocation above due to your unique individual circumstances. The asset allocation reflected above may fluctuate based on asset values, portfolio decisions, and account needs. Indexes represent securities widely held by investors. You cannot invest directly in an index. S&P 500 Index is a capitalization-weighted index calculated on a total-return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies. Wells Fargo and Company and its affiliates do not provide legal advice. Please consult your legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. This report is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities or strategies mentioned. The investments discussed or recommended in the presentation may be unsuitable for some investors depending on their specific investment objectives and financial position. Investing in foreign securities presents certain risks that may not be present in domestic securities. For example, investments in foreign and emerging markets present special risks, including currency fluctuation, the potential for diplomatic and potential instability, regulatory and liquidity risks, foreign taxation and differences in auditing and other financial standards. Some complementary strategies and real assets may be available to pre-qualified investors only. Real estate investments carry a certain degree of risk and may not be suitable for all investors. © 2014 Wells Fargo Bank, N.A. All rights reserved.

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