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Summary

  • With energy reform finally becoming a reality, Mexico is showing itself to be very aware of how to compete internationally.
  • Energy reform could mean strong momentum and outlook for Mexico, with high potential for increase in jobs, GDP, and demand for goods and services.
  • Mexico ranks high in fundamentals and risk, though low overall in our country ranking model.

Accuvest Global Advisors, a California-based RIA and sub-advisor of the AdvisorShares Accuvest Global Opportunities ETF (NYSEARCA:ACCU) and the AdvisorShares Accuvest Global Long Short ETF (NYSEARCA:AGLS), shares their thoughts on the Global Emerging Market.

We have been traveling regularly to and investing on and off in Mexico for over thirty years. We have seen the peso strengthen and bust a couple of times; government-owned banks privatized and then go bust; an ongoing roller-coaster ride in the Bolsa. Through it all, we have been big believers in the long-term prospects for the country, its economy, and financial markets. However, it is clear that a thoughtful process regarding entry and exit points is required.

High Valuations, Low on the List

In our country-ranking methodology, we have seen the Mexican (NYSEARCA:EWW) stock market move around our attractiveness list quite a bit. For several quarters, however, it has been lurking at the bottom of the pack, as extremely high valuations (relative to its own history as well as to the other thirty countries in our model) have kept the market in an unattractive zone, which currently means the absolute bottom of our list. Consider some of the positives and negatives related to Mexico in the following tables.

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For some of the reasons shown above, on a tactical basis, we have been without Mexico in our global and international portfolios and actually short in our long/short portfolio. There are some interesting headlines, however, that we are tracking closely. Energy reform has been talked about for decades, but is only recently, with the election of the new president Enrique Peña Nieto, actually becoming reality. Since 1917, with the creation of the current Mexican constitution, the government has controlled oil and its derivatives, basic petrochemical industries and the generation of electricity. In 1938, Presidente Lazaro Cardenas nationalized the entire Mexican oil sector. This has meant that, in practice, all profits that are generated from the state-run petroleum agency ("PEMEX") have flowed to the federal budget. Investments in new technologies, required capital expenditure, and deepwater exploration have been woefully insufficient.

Recent Regulation & Reform

In December, historic constitutional amendments were passed, laying out the terms under which private companies will be able to bid on energy projects. In April, the government laid out new proposals implementing regulations to its congress that will dictate how it plans to open up its oil and gas resources for international private investment. There are more key dates in the timeline towards eventual implementation. The biggest is a special session of Congress planned for mid-June, at which time Congress will debate and vote on the regulations that have been put forth. A simple majority of 51% is required for passage. Regulations will lay out the specifics on bidding rounds, contracts, tax structures, etc. There will be additional detail on the different type of profit-sharing arrangements companies can use, including licenses and production-sharing agreements.

Mexico is showing itself to be very aware of how to compete internationally. A 25% minimum national content threshold will be enforced staring in 2025. Both of those variables are considerably friendlier than the Brazilian market, which was privatized in 2008. An overhaul to the fiscal regime has also been unveiled which is quite progressive and should make investment in Mexico's energy projects more appealing. The royalty will be as low as 10%, which will compete aggressively with other international markets.

The Bigger Picture

Check back occasionally as we update the progress on this topic. The momentum and outlook is strong. What will it mean for the country, its markets, and investors? There are no real direct ways to play this theme via Mexican companies in a pure sense. There will be positive knock-on effects that will be analyzed and assessed for petrochemical, cement, infrastructure, and financial companies.

The bigger picture has to be seen as quite positive. It is hard to forecast precisely, but we are seeing research estimating 2.5 million new jobs by 2025. GDP could increase by 1% to 1.5% as a result of the reform. This kind of activity could translate into higher demand for goods and services. Emigration to the U.S. could subside. In the U.S., the multiplier effect in the energy sector shows one new job created in the oil and gas industry supports four more indirect jobs; hopefully that kind of multiplier effect will be seen in Mexico.

Government revenues certainly would increase, lower energy prices would reduce the need for electricity subsidies, and public financial pressures would ease. U.S. companies that currently operate in the Eagle Ford should find it easy to extend their expertise across the border where the same formation flows into Mexico. The geographic regions of Tamaulipas, Nuevo Leon, Coahuila, Dallas, Houston, San Antonio and the actual border towns could see huge direct investment. If these various benefits begin to show themselves as realities, the peso could strengthen as well. Mexico will be a strong candidate for rating agency upgrades.

Sources: Bloomberg, BBVA, Morgan Stanley, UBS, Credit Suisse

Disclosures: The opinions expressed in this report are those of the author. The materials and commentary are strictly informational and should be used for research use only. This brochure should not be construed as advertising material. The opinions expressed are not intended to provide investing or other advice or guidance with respect to the matters addressed in this brochure. All relevant facts, including individual circumstances, need to be considered by the reader to arrive at investment conclusions to comply with matters addressed in this brochure. Past performance is not indicative of future results. Remember that investing involves risks, as the value of your investment will fluctuate over time and you may gain or lose money. Investment risks are born solely by the investor and not by AGA. AGA is an independent investment advisor registered with the SEC. All disclosures, marketing brochures, and supplemental firm sheets are available upon request Charts and information used in this report are sourced from Accuvest Global Advisors, unless otherwise noted above.

Source: Mexico: A Country In Transition