(Reuters) - Latin America should suffer just a short, sharp shock to its financial markets when the U.S. Federal Reserve starts to taper its super easy monetary policy as investors remain convinced of the region's solid economic prospects and are attracted by its high-yielding assets.
Investors are coming around to the idea that when the Fed begins slowing the money printing presses and buys fewer bonds, it will be because the policy has succeeded in getting the U.S. economy to grow in a sustainable way. That growth should buoy global demand and help sales of Latin America's key exports.
Latin America has absorbed $400 billion in foreign inflows over the last five years as investors in low-growth developed economies like the United States, who could also borrow cheaply because of the quantitative easing policies of the Fed and other central banks, sought greater investment returns in higher growth regions.
A withdrawal of liquidity by the Fed, no matter how gradual, may prompt investors to sell some emerging market assets, which is likely to hurt stocks, bonds and currencies in the region.
But investors and analysts told the Reuters Latin American Investment Summit this week that any weakness will likely be short-lived as investors will be attracted by the region's relative economic stability and any decline in prices.
"I don't think the initial sell off will show a lot of mercy for most markets," said William Landers, who manages more than $6 billion of Latin American equities for the giant asset management group BlackRock.
Just a mere hint of an exit by Fed Chairman Ben Bernanke on Wednesday sent global stocks sharply lower and benchmark 10-year U.S. Treasury yields above 2 percent. But the yields in Latin America remained higher.
"I wouldn't expect to see en-masse outflows if you are seeing gradual rises in rates in the U.S. because of a better economic outlook, that is a positive overall," said Lazard Asset Management portfolio manager Denise Simon.
In Latin America, the share of foreign ownership of local currency sovereign debt has doubled from early 2008 to over 25 percent by the end of 2012, according to the International Monetary Fund.
And the nation with the biggest exposure to a Fed pullback is Mexico, which sends nearly 80 percent of its non-oil exports to its neighbor to the north.
Finance Minister Luis Videgaray told the Summit that Mexico is preparing by build up its foreign exchange reserves and attracting institutional investors to guard against hot money outflows when the Fed reverses course.
"It is not something that we think will happen in the coming weeks, nor probably in the coming months, but eventually global monetary policy will return to normal," Videgaray said.
The Mexican peso, which is fully convertible in contrast to other currencies in the region, is up over 3.3 percent against the greenback so far this year.
Mexico has one of the highest exposures in the region to foreign investment in its peso-denominated bonds, at around 40 percent, only exceeded by Peru.
"This is a new risk, potential risk factor, and one that we know ... (The central bank) is monitoring very closely," Moody's Senior Credit Officer Mauro Leos said.
When the Fed begins to pull back, which is expected before the end of the year, investors across all asset classes will face tough choices. For some, such as hedge funds, the sheer volatility from the event will be welcomed while others are trying to pick sectors that will be least affected.
In fixed income, where so much of the exposure is in long-duration sovereign bonds, there are higher risks, says Diego Ferro, co-chief investment officer at emerging market debt specialists Greylock Capital Management in New York.
"Shorter-term spread products of healthy companies, sounds a more interesting way to play this than long-duration, low-spread assets," said Ferro.
"The end of QE is going to promote some sort of unwinding from positions... Clearly long-duration, high-quality assets, there is a huge exposure," he added.
BlackRock's Landers maintains Brazil, despite its recent weak growth which has soured investor sentiment, still represents a good buy because of its growing middle-class, which drives domestic consumption.
He said he likes the consumer sector, especially retailers, Brazilian banks, and food stocks such as BRF Brasil Foods SA (BRFS3.SA). However he is shying away from materials and energy.
Investment grade rated countries such as Brazil, Mexico, Chile and Colombia will cope better with stimulus withdrawal, says Standard & Poor's sovereign analyst Joydeep Mukherji.
"The countries that we rate lower, the Ecuadors, the Venezuelas, the Argentinas of this world, by virtue of the fact that they are rated lower, means they have less cushion, so even under a benign scenario they would come under pressure and start losing export revenues," Mukherji said.
Editing By Dan Burns, Martin Howell and Leslie Gevirtz