3) Viva La Mexico? – Mexico continues to be one of our favorite places to hide out in EM within the context of our #UnderweightEM and Dollar #Bottoming? investment themes – the both of which have picked up steam of late. This morning’s decelerating inflation data for the month of March was confirming of both the trend lower in headline and core CPI, as well as our #Quad1 forecast for Q1. Furthermore, we see this persisting through Q3 of 2018. It is in this backdrop that Mexico (EWW; +5.9%) is outperforming all other major emerging markets indices in the YTD: EEM flat YTD; Brazil (EWZ; +3.8%); China (FXI; +0.8%); India (INDA; -4.2%); Indonesia (INDO; -5.2%); South Africa (EZA; -4.4%); South Korea (EWY; -1.4%); Russia (RSX; -5.9%); Taiwan (EWT; +4.2%); and Turkey (TUR; -8.0%).
A much improves valuation picture for Mexican equities, paired with a possible turn in the cycle and bullish setup for the Peso make for an interesting contrarian opportunity.
Investors thinking about Mexican equities can probably thank Trump for putting them on sale, as valuations have dropped from expensive to more neutral levels. In the process Mexican equity ETF AUM in the US has dropped to a 10 year low on an implied allocation basis.
One thing to look for when I see valuations fall is for some sort of improvement or bottoming out in the economic cycle after a period of slowdown. In this case, you can see the OECD composite leading indicator has dropped substantially, and you could argue on the monetary policy rate there is a certain component of ‘dry powder’, So it is starting to look like an interesting set up here.
Final thought on this topic is the currency (often times, particularly with emerging markets, if you buy the equities you’re often also buying the currency due to lack of attractive hedging options). And from a quick glance at valuation vs PPP and the sentiment indicator (combines implied volatility and futures positioning), the currency adds to the value case.
Geopolitics is obviously a big issue, but I would consider that 2-way risk. There’s every possibility that NAFTA comes back from the brink ( probably the key risk on that front). And if you add to that a softening in the monetary policy stance or improvement in the economic cycle picture it could help trigger a re-rating in valuations.
A much-improved Valuation picture for Mexican equities, paired with a possible turn in the cycle and bullish setup for the Peso make for an interesting contrarian opportunity.