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Mexico: not in crisis but hold the tequila

This piece is part of a two-part series on Mexico. The second part, a case study of a buying opportunity we found in the market, will be available next week.  

Following his outlandish campaign-trail declarations, the popular consensus is that the election of US President Donald Trump will be bad for Mexico. Indeed, with the country facing its own potentially challenging elections, the outlook for the Mexican economy should be decidedly negative. However, the risks presented by these scenarios appear to have been overplayed, with subsequent sell-offs creating attractive opportunities in the market.

Mexico’s economy: better than you think
Since the 1980s, Mexico’s economy has been characterised by periods of crisis and recovery. The 1980s, described as ‘the lost decade’ as falling oil prices increased national indebtedness, were succeeded by growth in the early 1990s as the North American Free Trade Agreement (NAFTA) took root. These gains were wiped out by the collapse of the peso in the ‘Tequila crisis’ before strong exports drove a recovery in the late 1990s. Then a US downturn brought recession back in 2001. Mexico was hit again by the 2008 crisis, before the proposed reforms of President Enrique Peña Nieto paved the way for the return of growth, although the recent collapse in the oil price has stymied some of these reforms. More recently, President Trump’s protectionist rhetoric – which includes ripping up NAFTA, implementing a border tax, forcing Mexico to pay for a new wall on their shared border and sending back 11m illegal immigrants – has triggered a sharp sell-off in Mexican assets and a 19% depreciation in the peso to a record low of 21.8 pesos to the dollar.

View from the ground
When we visited Mexico last month, we expected to find a country nervously anticipating the actions of the new US president. Instead, we found that sentiment had recently shifted after Wilbur Ross, the US Secretary of Commerce, said that a trade deal benefiting the peso would be favourable as this should make US exports cheaper. Since then, this optimism has been boosted by National Trade Council Director Peter Navarro's comments about creating a North American manufacturing power house to reduce imports from the rest of the world. Since its trough in mid-January, the peso has appreciated 15%.

Further, most Mexican businesses have already priced in the worst case scenario for the US trade deal in their forecasts and business plans. Their growth forecasts are significantly lower than the consensus views in the global market. Meanwhile, record-low unemployment and record high remittances have lifted consumer sentiment from its late 2016 doldrums.

Political risk:  it’s south of the border, too
The biggest immediate risk factor for the country now is the election in the State of Mexico (Estado de México or ‘Edomex’) in June. As the largest Mexican state by population, Edomex voters’ decisions have been indicative of the outcomes of subsequent presidential elections. The State of Mexico has been a stronghold of the governing party, the Institutional Revolutionary Party (PRI), but recent polls indicate that the Morena party, led by controversial leftist candidate Andres Manuel Lopez Obrador, is quickly gaining popularity. Obrador has openly criticised Mexico’s neoliberal economic model of recent decades, including the privatisation of state-owned companies and a range of structural reforms. In our view, the reversal of these reforms would be detrimental to the country’s sustainable growth and a significant market sell-off would likely follow a Morena win. Although many Mexicans still view this as unlikely, the vote for Brexit and Trump’s victory were built on anti-establishment sentiment, and a Moreno win is a very real tail risk in our investment case for Mexico.

Waiting for the tequila
Despite this risk, we believe there is limited downside for the Mexican economy. The peso has taken the brunt of the negative news and, given that it is trading close to historical lows, it seems to be pricing in the economic risks. This view is premised on a Morena loss in the Edomex elections; its victory would create a new set of uncertainties for the country.

We believe there is a reasonable chance that US trade policy will be more benign than expected, and that growth in the US will ultimately aid Mexico, its largest trading partner. If all of these challenges dissipate, as we expect them to, the market should perform in line with other emerging markets in the coming years – a much more promising outlook than is widely being touted.

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Paul Voute, Head of European Business Development