Home Trading ETFs GXG: Colombia Macro Outlook 2019 – Global X MSCI Colombia ETF (NYSEARCA:GXG)

GXG: Colombia Macro Outlook 2019 – Global X MSCI Colombia ETF (NYSEARCA:GXG)

by TradingETFs.com
GXG: Colombia Macro Outlook 2019 - Global X MSCI Colombia ETF (NYSEARCA:GXG)


The Global X MSCI Colombia ETF (NYSE:GXG) is the largest and most liquid country specific exchange-traded fund for Colombian equities. GXG offers investors good exposure to the underlying themes in the domestic economy through 27 holdings. Colombia’s GDP growth has averaged 3.7% since 2010, outpacing that of larger regional peers like Brazil and Mexico. The story has been an expanding middle class and resilient consumer dynamics, even as industrial production and investment demand slowed with the turn in the commodity cycle this past decade. Considering a slowdown between 2016 and 2017, moderate growth is expected going forward. Stable inflation and a business-friendly government support the favorable fundamentals. On the other hand, weakness in the external accounts along with questions related to the fiscal deficit trajectory highlight risks, particularly as it relates to the peso currency exchange rate. This article presents the current macro outlook, including my view on Colombia equities in GXG.

Colombia Macro Outlook July 2019

2018 GDP of 2.7% was a rebound from 1.8% in 2017 and 2.0% in 2016. GDP growth between 2010 and 2014 had averaged 4.8% per year, so the numbers now are something of a disappointment compared to exuberant expectations in the first half of this past decade. Oil represents over 40% of Colombia’s exports, and the collapse in energy prices from 2014 through 2016 clearly has a negative impact on growth. GDP growth fell to 1.8% in 2017. Sector activity took a big hit, bringing down national industrial production and investment demand. The drop in export prices resulted in a large imbalance in the current account when the deficit reached -6.3% of GDP in 2015. A wider fiscal deficit over the period was the perfect storm setting the Colombian peso currency to depreciate nearly 50% from its highs against the US dollar back in 2014. The devaluation here was necessary to adjust terms of trade that has resulted in a more competitive currency that now trades at COP 3200 per USD.

(Colombia GDP Growth. Source: Grupo Bancolombia Presentation)

The Central Bank of Colombia is currently forecasting GDP growth of 3.2% for 2019, which would be the highest rate since 2014. Unfortunately, there is some growing skepticism among some sell-side institutions that the estimate is achievable. Activity indicators for the first half of 2019 have been weaker than expected. Banco Itau Economics Research is more bearish, estimating GDP growth of 2.6% for 2019 essentially flat from 2018. Their view which I share is that the risks are titled to the downside, and growth in the second half of 2019 should underperform.

(Colombia Macro Indicators and Forecast. Source: Itau Economics Research)

Considering Q1 GDP growth of 2.8%y/y, a more meaningful acceleration for the rest of the year will be required to achieve the Central Bank’s official target of 3.2% GDP growth for the year. Manufacturing and construction have been weak, while resilient retail sales are supporting growth. The unemployment rate has been trending higher and reached 10.5% in May, compared to 9.7% for the period last year, suggesting less dynamic consumer spending support going forward. The idea here is that weaker consumer confidence along headwinds from the external environment, including uncertainty regarding global trade, are the main reasons pointing to tepid growth for the remainder of the year.

(Colombia Macro Indicators and Forecast. Source: Itau Economics Research)

Stable inflation within the Central Bank target range remains a bright spot in the economy. The annual inflation rate in May was reported at 3.3%, down from levels as high as 9% back in 2016. Inflation is expected to remain around 3% through 2020. The Central Bank last held its policy rate at 4.25% in its last meeting. Minutes released show that the board is concerned about geopolitical and trade tensions, and noted that a deterioration of the global scenario could lead to monetary easing around the globe. The market expectation is that a rate cut to 4% could come as early as the next meeting and would coincide with a global trend of more dovish monetary policy to support growth. The next monetary policy decision will take place on July 26.

Moving on to the weaker areas of the economic scenario, lower oil prices in 2019 compared to the average for 2018 has pressured the trade deficit in Colombia. Lower coal production and exports are also a culprit. The trade deficit ended 2018 at about 7.1 billion and is expected to expand this year to 12.7 billion, as imports grow by 9.4% compared to a 1.8% drop in total exports. The current account deficit is estimated to reach 4.3% of GDP from 3.9% in 2018.

(Colombia GDP Growth. Source: Grupo Bancolombia Presentation)

The other concern is the fiscal deficit that remains around 3% of GDP. Colombia’s public debt as a percentage of GDP is at 47%, up from 31.5% going back to 2012. In recent years, the government made efforts at cutting taxes in an effort to boost growth, although this has led to a poorer fiscal outlook going forward based on lower tax receipts. The government is counting on higher growth and a trend of formalization in the economy to fill the gap of tax. Nevertheless, the government’s target for the debt level to trend lower over the next decade appears difficult to achieve. The required counter-cyclical spending cuts will weigh on economic activity. Grupo Bancolombia Economics Research views the level of debt as remaining around 45% over the next 6 years, above the government’s more aggressive target seeing a reduction to 37.5% by 2025. Rating agencies have cited fiscal uncertainty as one of the primary weaknesses in the sovereign credit rating.

This year, Moody’s and Fitch revised their outlook for Colombia’s sovereign rating in opposing directions, reflecting opposing views on Colombia’s fiscal outlook. Fitch’s “BBB” revised its Colombia sovereign credit outlook to negative, while Moody’s “Baa2” changed the view to stable (from negative). S&P Ratings is one equivalent notch lower at “BBB-” and maintains a stable outlook. Fitch’s negative outlook reflects its concern over the fiscal outlook, citing constantly changing targets and weaker-than-expected figures in the recent period. The main uncertainty here is the price of oil, as the economy remains leveraged to oil prices. A move higher in the Brent crude oil benchmark could provide some breathing room in terms of growth and fiscal receipts to reach targets.

Consistent with current conditions, my take is that the Colombian peso currency could face further depreciation pressure given the combination of a wider current account deficit, higher public debt levels, along with downside risks to growth. The current exchange rate at 3200 COP per USD is near the all-time low for the peso against the dollar, and a further deterioration in the macro outlook could represent more depreciation. The US dollar is up nearly 40% against the peso in the past 5 years. Note: A higher exchange rate level here represents a depreciation in the currency.

(USDCOP exchange rate. Source: TradingView)

GXG ETF Analysis

GXG is concentrated among stocks in the financials sector, which represent 47.82% of its holdings. The upside is that banks here typically reflect trends in the local economy and have cyclical exposure to the business cycle with upside on better-than-expected growth. A long position in GXG would be consistent with a bullish outlook on the Colombian economy.

(GXG Holdings and Sector Exposure. Source: Global X)

Bancolombia SA (NYSE:CIB) is the largest holding and represents 23.2% between the ordinary and preferred shares in the ETF. The bank has $67 billion in total assets and is among the top 10 in largest Latin America banks. The actual exposure to CIB is even larger, since investment holding company Grupo de Inversiones Suramericana SA (OTCPK:OTCPK:GIVSY), representing 6.95% of the GXG weighting, actually controls 46% of CIB common stock and 24% of total equity. By this measure, GXG is approximately 25% in Bancolombia. State-controlled oil company Ecopetrol SA (NYSE:EC), with a weighting of 14.53% in the ETF, is the second-largest holding. EC is particularly leveraged to oil prices given extensive exports, but is also the dominant player in domestic downstream. Utilities representing 14.26% are another source of exposure to the local economy. Overall, the concentration here is high and diversification isn’t the best, but I like GXG as a proxy of sorts on the Colombia peso.

Considering some of the actively traded Colombian ADR performance over the past year, the total returns have been relatively flat, although the year-to-date performance reflects a strong rebound from depressed levels at the end of last year. Bancolombia is up just 4.2% over the past year but up 35.6% year to date. Similarly, Ecopetrol is down 1.6% over the past year but is up a more impressive 27% in 2019. GXG is down 6.8% over the past year but up 25% year to date.

ChartData by YCharts

Conclusion and Forward-Looking Commentary

The Colombian economy is fundamentally stable with a positive long-term future. I’m bearish on the GXG ETF in the near term, based on my view that the macro outlook has some weakness. I see the wider current account deficit, higher public debt levels, and downside risks to growth as weighing on the currency. Further depreciation of the Colombian peso against the US dollar would be likely result in negative returns for GXG and renewed poor sentiment. External risks related to the unsettled U.S.-China trade dispute, along with emerging signs of global cyclical weakness, could pressure the price of oil, leading to downside pressure for Colombia’s growth estimates. I believe the risks are titled to the downside and see GXG retesting its May 2019 low around $8.50 per share, representing ~10% downside by the end of the year. To the upside, better-than-expected macro indicators, along with a sustained rally in oil prices, would be bullish.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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