Mexico: Who dares may win
The uncertainty around Mexico’s future relationship with the US could create an opportunity for braver investors to get into the market, says Rodrigo Amaral
At a glance
• The advent of the Trump administration has hit Mexico hard.
• The Mexican economy is highly integrated with its northern neighbour.
• Implementing protectionist policies may prove difficult for the US as many American firms could be hit hard.
• Brave investors could see the over-reaction to the likely impact of the Trump administration on Mexico as a buying opportunity.
For Mexico the impact of the Trump administration is akin to an earthquake, a tsunami and a volcanic eruption combined. Mexico, which is Latin America’s second-largest economy and hugely dependent on the US, has been the target of some of President Donald Trump’s most vicious tweets. Not only that, the new US government has started to implement policies that could have a dire effect on the Mexican economy. Under such circumstances investors in Mexican securities have reacted to the new US order like everybody else: with sheer panic.
The Mexico Stock Exchange’s main index, the IPC, stood at about 48,500 points before the US election on 3 November. Two weeks later, it had dropped below 44,400 points and it has been up and down since then. Mexico’s currency, the peso, has also plummeted against the dollar. Just before the election, a dollar bought 18.5 pesos – after Trump took over the rate has hovered between 20.5 and 22 pesos. The cheaper currency is feeding inflationary pressures, which has pushed the central bank to raise interest rates, making economic growth harder to achieve.
Analysts expect flows of foreign direct investment into Mexico to dive in 2017 as uncertainty about the future of the operations of foreign companies in the country remain unclear. Ford and Toyota have already scrapped plans to invest in Mexico as a reaction to Trump’s pressures to make cars in the US. More companies could follow their example, forcing the Mexican authorities to do something about it. “If too much capital flees, the government may be forced to implement capital control policies or to be very aggressive with interest rates,” says Juan Camilo, the head of investment strategies at Credicorp Capital, a Colombian asset manager.
The rollercoaster ride is unlikely to end any time soon. Trump has issued threats that range from the construction of a border wall to curb immigration to the deportation of Mexican nationals living in the US and halting cash transfers from Mexican workers to their families in Mexico. On the trade side, Mexico has been blamed, along with China, as an economy that has benefited most from excessive US largesse when signing agreements. President Trump wants to renegotiate the terms of North American Free Trade Agreement (NAFTA) and impose extra tariffs on Mexican imports to raise revenue and pay for the border wall.
Add to all that a penchant to describe many Mexican migrants as drug dealers, criminals and rapists, and it is fair to say that Trump is not the most popular American south of the Rio Grande. “I support 100% the decision of [President Enrique Peña Nieto] of not meeting the clown Donald Trump,” tweeted Ricardo Salinas, one of Mexico’s wealthiest businessmen, after a meeting between the two presidents was cancelled.
Unfortunately for Mexicans, bravado will hardly help, at least in the next four years. Mexico has in fact benefited much from the advantages of access to the American market conceded by NAFTA. Maybe too much: today 80% of the country’s exports move north of the border. In the past few decades, Mexico has followed the recommendations coming from Washington and reformed its economy to become an export-driven powerhouse. It is disappointing then that the same US is threatening to impose tariffs on its products while global trade growth as a whole is slowing down. “The Mexican economy is expected to have decelerated from 2.5% in 2015 to 2.1% in 2016, and will likely decelerate further in 2017,” says Thomas Smith, manager of the Neptune Latin America Fund.
But all may not be lost when it comes to the Mexican economy and investing in the country’s securities, which rank among the most liquid assets in the emerging markets universe. All things considered, President Trump’s policies may not be as enforceable or efficient as he claims. The effects on Mexico could be less dramatic than the initial reaction from markets has suggested. “First of all, it will be necessary to distinguish what is rhetoric and what is reality,” says Jan Dehn, the head of research at Ashmore, the emerging markets-focused asset management group. “In the lack of a clear framework of how Trump will implement his policies, the market is reacting too much to the tweets.”
For example, scrapping or renegotiating NAFTA will probably meet plenty of resistance within the US itself, as many US companies have their supply chains deeply embedded in the neighbouring country. A large number of American jobs are dependent on exports to Mexico: while the US bought $316bn (€297bn)in manufactured Mexican goods in 2015, trade the other way around reached $267bn. When it comes to services, the US had a surplus of $9.2bn in 2015, according to the United States Trade Representative.
According to Dehn, imposing a border tax on Mexican imports will likely result in higher prices for US consumers, as many goods purchased from Mexico are not easily replaceable by local American production. And the new tariffs, which may range from 20-35%, should be largely offset by the peso’s plunge. The optimistic view, therefore, is that the Trump administration will embrace reason with the passage of time.
Smith says that, in the long run, Mexico appears to be on the right course, especially after Peña Nieto implemented several controversial, but necessary reforms in areas like energy, tax rules, labour laws, education and others. “As the structural reforms bear fruit in the coming years, Mexico’s economy could return to growth rates above 4% by the end of the decade,” he said.
For brave investors, the current woes faced by Mexico could constitute an opportunity. “With all this uncertainty, valuation-based opportunities are created all the time,” says Ilan Furman, a portfolio manager at Columbia Threadneedle. “For example, companies that are benefiting from the energy and electricity reforms offer an interesting investment horizon. The rate hike is boosting the profitability of banks, and we are still seeing a healthy consumer environment.” He urged investors to be cautious, though, as uncertainty levels remain high.