Often considered NAFTA’s weakest link, the emerging market is coming on strong
David Pett, Financial Post Published: Saturday, April 10, 2010
April is turning into another impressive month for North America’s hottest market … Mexico.
On Monday, the Mexican Bolsa index, the country’s top equity benchmark, hit a new high, only to soar even higher yesterday. The Mexican peso, meanwhile, reached its highest level since early October 2008 yesterday and remains the top-performing currency among emerging markets this year.
But that’s not all. The month started with Citigroup Inc., saying the country’s bonds are eligible to be included in its world government bond index, making it the first Latin American country in the closely watched index.
Not even Canada and its parity-busting loonie can top that kind of economic momentum. With the U.S. recovery only now starting to find its groove, there seems little doubt among analysts that Mexico will continue to move in the right direction, despite the violence that regularly grabs international headlines.
"Mexico has become an interesting place again for investors and we are confident there is more money to be made in this market," said Claudia Medina, a senior analyst with Banco Itau S.A., an asset management firm based in Sao Paulo, Brazil.
Last year at this time, investor sentiment toward Mexico could not have been more different.
Like most other countries around the world, its economic growth suffered greatly from the collapse in trade and the global financial crisis, falling 6.4% in 2009. However, Mexico’s economic troubles also lasted much longer than its Latin American peers. While Brazil’s economy was bottoming in the second quarter of last year, Mexico’s huge dependence on a still-fragile U.S. consumer, an escalating drug war and the swine flu outbreak continued to weigh heavily.
Then in the latter half of 2009, Both Standard & Poor’s and Fitch Ratings downgraded their credit ratings for Mexico’s foreign currency debt following congressional elections that failed to produce meaningful fiscal reform.
"The year 2009 seemed to confirm all the fears put forward by the bearish camp," said Pierre Fournier, a geopolticial strategist at National Bank.
Today, Mexico’s economy is expected to grow roughly 4% in 2010, representing a trough-to-peak increase of 10% in just one year. The only other country expected to grow that quickly is Turkey.
Nick Chamie, global head of emerging markets research at RBC Capital Markets in Toronto, said the problems that slowed the recovery last year have largely come to pass, leaving Mexico free to play an effective game of catch-up through the first quarter of this year.
"The economy has certainly rebounded nicely following last year’s disastrous results," Mr. Chamie said.
The strong recovery is being led primarily by Mexico’s manufacturing sector as it benefits from the improving U.S. economy.
The U.S. market represents 80% of Mexico’s total exports, which accounts for 27% of the country’s gross domestic product.
As a large exporter of oil and home to a burgeoning mining industry, Mexico has also gained from the increase in commodity prices over the past six months to a year.
Another advantage is the country’s strong fiscal situation. Despite the political noise about fiscal reform late last year, Mexico’s government debt-to-GDP ratio hovers in a very acceptable range of 35% to 40%.
"That leaves it in very good stead in comparison to almost any other major economy," Mr Chamie said.
With a good chance that Mexican markets will pull back following such a strong run in a very short period of time, Mr. Chamie is predicting a more modest pace in gains over the next year. Over the next few months, he believes Mexico will remain attractive assuming growth remains positive and economic fundamentals continue to shine through.
Specifically, he sees good value in the country’s fixed-income market and recommends investors take an overweight position in Mexican bonds.
The peso, which remains almost 25% below its 2008 high, also looks relatively cheap compared with its Latin American peers, he said.
How markets in Mexico will perform six months to a year from now will depend largely on U.S. growth and the trajectory of commodity prices, Mr. Chamie said.
Less of a concern is the country’s protracted drug wars, which have destabilized the northern region of the country.
"To the extent that everyone is aware of the drug wars it is already priced into markets and is not a huge barrier to investing," he said.
As for the country’s stock market, Vincent Delisle, a strategist at Scotia Capital Markets, said there also appears to be more upside in store. He told clients this week that corporate earnings in Mexico will jump 23% in 2010 and 16% in 2011.
By comparison, he forecasted Canadian earnings to rise 29% for 2010 and 10% the following year.
Already up more than 90% since the March lows last year, Mr. Delisle has a Bolsa target of 36,250, a 7% increase from yesterday’s closing price of 33,840.85.
Reiterating a North American preference in his asset allocation, the strategist recommended U.S. stocks over Europe, Canada over Australia and Mexico over Brazil.
Ms. Medina’s firm, which manages the Excel Latin American Fund in Canada, is currently 5% overweight Mexican stocks, favouring the industrials and materials sector over consumer and telecommunications stocks.
"We continue to believe that growth in the Mexican economy will come more from manufacturing exports than from domestic consumption, and hence our strong position in industrial companies with high exposure to the United States and Brazil," she said.
Her top picks include steel company, Ternium S.A., a major supplier to the U.S. automotive industry with operations in Mexico and Argentina, and Alfa S.A. B de C.V., an industrial conglomerate that produces high-tech aluminum auto parts.
The firm boasts significant holdings in petrochemical company Mexichem S.A. B de C.V., and Grupo Mexico S.A. B de C.V., the country’s largest mining company.
Investors can buy ADRs of Ternium and Mexichem in New York. Or, for broader exposure to the Mexican market, iShares offers the MSCI Mexico Investable Market ETF, priced in U.S. dollars.
Alternatively, there are several Latin American ETFs and mutual funds.
With new consumption taxes taking hold in January, Ms. Medina said Mexico’s beleaguered consumer will remain stressed over the short term, but she believes that, eventually, success in the manufacturing sector will lead to better domestic consumption.
While Mexico surely faces serious challenges ahead, including an economy too dependent on the U.S. consumer and a political environment that has been dogged by ineffective government and corruption too often in the past, Mr. Fournier said those risks, on balance, are outweighed by Mexico’s positive long-term fundamentals.
With an increasingly competitive manufacturing sector, a strong resource base and superior corporate growth prospects, he expects Mexican stocks to outperform U.S. indexes over the long term.
"Sentiment about Mexico is clearly and finally beginning to turn," he said.