When I think of “old school” emerging markets (EMs), I think of Mexico. What started out as an exercise to determine if Mexico could be a “Biden trade” soon turned into my belief that some Mexican equities could perform well going forward regardless of the election outcome.
Mexico is not a “COVID reopening” trade, in my view, because President Andrés Manuel López Obrador (AMLO) neither locked the country down aggressively amid the pandemic, nor took any bold steps to stimulate the market. In fact, by not pursuing deficit spending in response to COVID, Mexico’s balance sheet may hold up better than most EMs’ heading into 2021.
More to the point for investors, some Mexican companies appear to be pivoting toward several quarters of better-than-expected earnings growth, with their stocks available at potentially compelling discounts.
Mexico has seen better days…
To be sure, Mexico’s investment story has been a sad one for years now (Figure 1):
- Before President AMLO (pre-2019), the economy was more or less “stuck”; reform efforts had either stalled or failed to deliver results.
- President AMLO’s arrival essentially “scared off” private investment in Mexico, dealing another blow to its already-challenged economy.
- As of this writing, the economy looks poised to contract by more than 10% in 2020, with only a tepid rebound forecast for 2021.
- Mexico may lose its investment-grade sovereign bond status in 2022, while its local stock market liquidity has all but dried up.
- Reflecting these concerns, country risk — as measured by Mexico’s 10-year sovereign spread over US Treasuries — is the highest it’s been in 22 years.
In short, investor expectations around Mexico are set about as low as I can ever remember.
But Mexico has a distinct advantage…
On the plus side, Mexico’s key advantage is its geographic proximity to the US and its tight link to the US business cycle. For example, Mexico’s manufacturing exports to the US comprise more than a quarter of total Mexican GDP.
Fortunately, that advantage remains intact. Even when President Trump pushed for new tariffs and the so-called “border wall” with Mexico, few serious manufacturers rolled back their supply chains. Global firms that want cheap access to the US market still simply can’t ignore Mexico.
And better days may lie ahead
There are also some “silver linings” and/or modest positive surprises we might see out of Mexico in the coming quarters:
- Although divided government has dimmed hopes for massive US stimulus, the prospect of a sizable infrastructure package could help spur faster US/Mexican GDP growth.
- Low US interest rates continue to buoy the hot US residential market, supporting Mexican consumption by providing healthy remittances to many families back home.
- If President AMLO were to tone down his anti-private-investment rhetoric, it could help unlock a steady trickle of longer-term private investment in Mexico.
- On that note, the potential for relative US dollar weakness in the period ahead could help drive further upside via Mexican peso appreciation.
- Mexico’s country risk (see above) is too high, in my judgment, given the country’s gradual recovery path.
- In my view, it won’t take much in the way of additional liquidity to move Mexico’s stock market higher, especially considering today’s historically attractive valuation levels.
Time horizon matters here
Right now, my time horizon for investing in well-positioned Mexican equities is 6 – 12 months. I would need to see Mexico’s political opposition make a dent in the July 2021 elections, and force President AMLO to alter his policy path, in order to extend my horizon.