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By Dion Rabouin
Aug 19 (Reuters) - Brazil and Argentina have seized the emerging markets spotlight in recent months thanks to investor-friendly political upheavals, but much smaller Peru is quietly stealing the show.
Peru's S&P Lima General Index has topped all global emerging markets in local currency terms in 2016, romping to a 58 percent gain and far outpacing the 33 percent rise for Argentina's Merval and the 37 percent jump for Brazil's Bovespa over the same period. (Graphic: http://tmsnrt.rs/2aW47eN)
In currency-adjusted terms, Peru is the world's No. 2 market after Brazil, which has benefited from a big rally in its currency, according to an MSCI ranking.
Beyond an economy that's grown steadily in recent years, some of the credit for the rally belongs to the emergence of Pedro Pablo Kuczynski, a former World Bank official and Wall Street banker popularly known as PPK, as a serious contender for the presidency earlier this year.
Even before he eked out a narrow run-off election victory in June, Kuczynski had lifted investors' hopes with a plan for infrastructure investment, small businesses assistance and jobs programs. The Lima General index rallied 8 percent when Kuczynski finished second in preliminary elections in April and leftist candidate Veronika Mendoza was knocked out of the race.
On Thursday, just a few weeks in office as president, he reiterated calls for lower taxes, saying his plan would boost government revenues by broadening the payer base.
With Kuczynski at the helm, "Peru is in the best shape that it has been in the last 50 or 60 years," said Javier Creixell, portfolio manager of Epiphany Funds' Latin America Fund in Dallas.
Creixell anticipates Kuczynski will usher in a number of important changes for the country, including increasing foreign investment and pumping up Peru's bread-and-butter mining and banking sectors. He also expects the newly elected president to grow the country's pension funds, which should help encourage savings, bolster Peru's financial system and provide for retirees.
MANAGEABLE MARKET HEADWINDS
While Peruvian companies are no longer cheap after the rally, they remain reasonably priced. The Lima General Index trades at 14.26 times earnings, well below the S&P 500's 20.00, even though it has dwarfed the S&P's 7 percent 2016 return.
MSCI's Peru index has a price-earnings ratio of about 13.5, slightly higher than MSCI's overall emerging markets index PE of about 12.1.
But the road to further gains in Peru, which has seen big commodities-driven rallies that have fizzled in the past, may not be so easy. Aside from its reliance on volatile gold and copper prices, the market suffers from a lack of liquidity in its equities market and PPK's own mixed prospects for pushing his reforms through an opposition-controlled congress.
Compared to challenges in Brazil and Argentina, Kuczynski's task in guiding his country is simplified by his ability to build on the foundation of his market friendly predecessor, former President Ollanta Humala. While his party only controls a scant 18 seats in Peru's 130-seat congress compared to the 73 controlled by his rival party, so far they have promised not to obstruct Kuczynski's agenda.
In contrast, Brazilian interim president Michel Temer and Argentine leader Mauricio Macri, also investor favorites, are undertaking what analysts believe will be much trickier and unpopular austerity measures that represent policy U-turns from their more interventionist predecessors.
"You're starting from a much higher base from an investor's point of view," said Dirk Schnitker, an analyst who heads Latin American equities at Auerbach Grayson in New York, referring to Peru.
Peru boasts a growth rate of 4 percent with 7 percent unemployment, and inflation a tick below 3 percent, though its $192 billion economy is a fraction of Brazil's $1.77 trillion. Both Brazil and Argentina are grappling with negative 2016 growth rates, unemployment rates above 10 percent and double-digit inflation.
HISTORY SHOWS ROOM TO RUN
With a market capitalization of about $75 billon, Peru's stock market remains modest in size. The country's MSCI index boasts just three companies - Credicorp Ltd , which controls Peru's biggest bank, Banco de Credito, and miners Southern Copper Corp and Compania de Minas Buenaventura. A risk is MSCI could downgrade it to frontier market status if any of the three companies are recategorized.
Even so, bottom-up investors who purchase assets based on individual companies rather than regional factors are singing Peru's praises.
"It's not a deep market. But when you look at the banking sector, it's one of the most attractive" in the emerging markets, said Will Pruett, manager of Fidelity's Latin America Fund in Boston. He holds overweight positions in both Credicorp and Intercorp Financial Services Inc.
Credicorp and Intercorp, a banking, insurance and wealth management group, trade at 2.4 and 2.5 times book value, respectively, in the upper range of valuations for Latin American banks. But they offer the highest economic value added, or EVA, a measure of net profit measured by the return on equity minus the cost, Pruett said.
"The banks are very well run, very profitable. There's good corporate governance, long growth opportunity and the valuations, even after the recent price appreciation of those stocks, are still quite attractive," Pruett said.
The 58 percent appreciation in the Lima General Index this year is impressive. But it is only the fourth largest rally in the last decade. The index rose by 168 percent in 2006, 101 percent in 2009 and 65 percent in 2010. And the market is still well below its peak, touched in April 2012, of 24,095.29.
While market fluctuations that great can flag troublesome volatility, eight fund managers told Reuters they have a positive outlook.
"This president is going to be very good for Peru," said Epiphany's Creixell, who holds positions in Credicorp, Southern Copper, Buenaventura as well as Peru's iShares ETF. "He's going to be good for the markets ... and good for the international community."
(Reporting by Dion Rabouin; Additional reporting by Rodrigo Campos; Editing by Christian Plumb and Edward Tobin)