The stability of the Mexican market hinges on “three big ifs”, says Lars Schonander, head of equity research at Santander in Mexico City. “Mexico’s domestic fundamentals look very, very strong, but the actual outcome will depend to a huge degree as to how things play out in Asia, the extent to which Brazil, Argentina and Chile avoid too much of an impact from the Asian crisis and to the extent to which the Dow avoids a collapse.”
Exposure to Asia is minimal, he points out, with the real impact being on low commodity prices such as oil and metal. “Beyond that, the impact on exports will be fairly minimal.” Economic growth, which he estimates at 5%, will come from within thanks to growing domestic demand rather than exports.
Mexico traditionally has a high correlation with the US market and approximately 80% of trade is done with North America. On the positive side, this makes Mexico better insulated from the effects of Asia than other emerging markets. But while the good news is driven internally, the possible bad news for Mexico is almost certainly controlled by outside forces, says Frederico Laffan, analyst at Warburg Pincus in New York. Pointing out that approximately 65–75% of the market float is in the hands of non-Mexicans, he says, “It is very exposed to the whims of foreign investors. Given the volatility of the US market it is something to have concern about.”
Foreign investors seem to have adopted the herd instinct, with the withdrawal from the Asian markets leaving Mexico very attractive for many.
“There has been a growing consensus over the past few months that Mexico is the market to be in. Almost all strategists are recommending overweight positions in Mexico – a lot of investors have moved into Mexico, out of Asian markets there is sort of a flight quality and this has pushed valuations up quite highly in a number of sectors. That’s a concern.”
But, says Schonander, Mexico is in a “solid position” and is not vulnerable to an “economic slowdown” this year. He predicts a continuation of the tendency towards lower inflation and lower interest rates “which should continue to help the market”. The IPC index is expected to reach 6700 compared with its 1997 close of 5229. In terms of returns on the stock markets, he is looking at 17% in dollar terms year to year.
“From an external point of view, Mexico is in a solid position and I think that has been shown by the way the exchange rate has behaved since October,” Schonander continues. “On days when the world was coming to an end the peso has weakened significantly but as soon as the market calms down, we’ve seen a reversal of that with the peso returning to more normal levels.”
He cites the main reason for this as one again linked with foreign interests: “Mexico does not have a significant current account deficit – most of the current account deficit is being financed by foreign direct investment. Last year’s deficit was fully financed by FDI.”
But while Laffan admits that the current situation might point to more prosperity for foreign investors, he warns of disappointments ahead. The recovery from the recession has been “faster than expected”, he says. Inflation has come down and should continue to fall to about 13% this year. But in comparison to the other Latin American markets, Mexican stock performance has been dragged down by overly high valuations. “It has actually done than worse than Argentina and Brazil, so that is a bit counterintuitive at first when you consider the macroeconomic stability of Mexico at the moment.”
He continues: “If you look at valuations in Mexico’s case for example, it’s trading the 1998 price earnings ratio of about 14 times compared to Brazil at 7.5 and Chile at 11 times. The implication here is that Mexico has discounted a lot of its recovery already.”
He says that the earnings growth figures need to be placed in context as they have been drawn on a comparison from a low base starting in recession, so the earnings growth for 1997–98 will look far more attractive than the next year to year figures. “Particularly comparing 1999 to 1998 it will be more difficult to show this type of earnings growth,” he says. Earnings growth is predicted at 25% in dollar terms for 1998, which is the highest in the Latin American region, but Laffan isn’t convinced that this figure represents “genuine growth”.
“My concern is that there could be a potential disappointment, because this is the tell-tale year of whether this is a year of genuine growth and recovery or was 1997 a partial mirage of very favourable comparisons from a very low base.”
Instead he makes an estimate of somewhere between 15% and 20%, warning that the market will remain “vulnerable” to external events.
On sectors, Laffan favours the home building sector and cement stocks, and airs concern over the oil industry “There’s an issue now of government investment declining because of the fall in prices.”
Schonander not surprisingly prefers domestically oriented sectors to exporters. “Their is more room for profit growth on the domestic side.” He recommends low-income housing construction, citing Hale, the market leader, retail sectors – Soriana and Commerci in particular with the former performing better – and in the beverage sector, he recommends Pepsi. Rachel Oliver