Latest Emerging Market Viewpoints
From Matt Linsey and the North of South Capital team
It has been a year since Trump assumed the office of President of the United States. At the time there were concerns that he would follow through on his election rhetoric and that a trade war would soon begin, with Mexico and China as the main targets.
At the time we cautioned that given Trump’s stated objective of higher economic growth, this approach would be self-defeating. Instead he would focus first on deregulation, then tax cuts in order to help accelerate economic growth. If this was not successful in getting the economy moving, the Trump administration would then look to get Democratic support to pass a major infrastructure spending programme. Only if these all failed to stimulate the economy did we think he would resort to more aggressive action on trade.
One of the markets most negatively impacted by fears of a trade war was Mexico. The Mexican index declined by close to 20.0% in U.S. dollars from the period of Trump’s election to his inauguration a little over two months later. This was a significant underperformance compared to the MSCI emerging market equity index which was flat during this period.
Once the market realised that the new American President would not begin office by abrogating NAFTA and proposing a border tax as originally feared the market rebounded by 22% in U.S. dollar terms over the next three months. This was well ahead of the 7.0% U.S. dollar gain by the emerging market equity index over this period.
Despite the acceleration of the U.S. economy towards the second half of last year this marked the relative peak in its performance, with the Mexican index actually declining in U.S. dollar terms from the end of April to the end of last year, compared to a 20.0% gain in U.S. dollars by the emerging market index over this period. This was despite a rising oil price and acceleration in the U.S. economy, both of which have been historically positive drivers of the market.
This renewed underperformance has been due to two main factors: 1) renewed fears that the leftist candidate for the upcoming Presidential election in July of this year, Andres Manuel Lopes Obrado (AMLO) stands a very good chance of winning and 2) renewed concerns that the U.S. will unilaterally withdraw from NAFTA.
The first reason is indeed concerning given his past rhetoric. Despite the unpopularity of the current government and the ruling party (the PRI) we still believe his chances of victory are less than 50%. Opposition to AMLO is across the political spectrum ranging from his former left leaning colleagues in the PRD, to his former colleagues when he was a member of the PRI, to the more right leaning PAN. We believe they will unite in order to prevent him winning the election. To those who say that AMLO’s negative ratings rival those of Trump before his victory we would caution that AMLO probably has a limited amount of “hidden” support which ultimately made the difference for Trump in the U.S. election.
As for the elimination of NAFTA it remains a real risk. Despite this fact it is hard to overstate how competitive Mexico is as a manufacturing location, even more so after the recent weakness of the peso. We recently met with a Korean auto company with plants located throughout the world. Mexico was by far their least expensive production location, easily more than 50% cheaper than its closest rival. What was most surprising about their production facilities in Mexico was that despite the relatively low wages, productivity was the same as in their developed market locations.
With the U.S. economy projected to be fairly strong over the coming year due to the impact of the recent tax cuts, Mexico should be a relative beneficiary compared to other emerging markets. Equity valuations relative to the U.S. market are now at one of their lowest levels in the past ten years. And on a sector basis a number of Mexican companies now trade at unjustified discounts to their global peers.
One example is automotive supplier Nemak, which trades at only 5x EV/EBITDA prospective 2018 earnings with a dividend yield in excess of 6.0%. The cement company Cemex, which has a significant exposure the U.S. market, trades on only 8x prospective 2018 EBITDA despite reducing its overall debt burden by more than 40% over the past five years. And finally, Grupo Mexico, one of the most globally competitive copper miners, trades at only 7x 2017 EBIDTA.
IMPORTANT INFORMATION | Issued and approved by Pacific Capital Partners Limited, a limited company registered in England and Wales, authorised and regulated by the Financial Conduct Authority. The information contained herein is not approved for use by the public and is only intended for recipients who would be generally classified as investment professionals. Information or opinions contained in this article do not constitute an offer to sell or a solicitation, or offer to buy, any securities or financial instruments or investment advice or any advice or recommendation in respect of such securities or other financial instruments. Where past performance is shown it refers to the past and should not be seen as an indication of future performance.
Donald Trump Photo by Gage Skidmore