Risks To The 'Mexico Moment': Part 2

 |  Includes: DBMX, EWW, SMK, UMX
by: Invesco US


Mexico’s president has embarked on an ambitious reform agenda, and investors are flocking to Mexican equities, bonds and real estate with high expectations.

We remain constructive on Mexican assets, but there are risks that investors need to monitor.

This piece looks specifically at exports and political corruption.

By Jack Deino

This is the second in a two-part series examining the risks that face Mexico today.

During a recent trip to Mexico, we met with multiple companies and government officials. We remain constructive on Mexican assets thanks to President Enrique Peña Nieto's aggressive reform agenda. However, we also see risks that, from our perspective, require consistent monitoring. Part 1 of this series discussed the risks of fiscal reform and energy reform. Here, I take a closer look at exports and political corruption.

The problem with exports

While Mexico has made great strides in diversifying its foreign trade by signing 12 free trade agreements with 44 countries in recent years, it cannot escape reality that about 80% of exports still go to the U.S. When the U.S. catches a cold, Mexico comes down with the proverbial flu. While we have heard much from high-level Mexican officials recently, including Finance Minister Luis Videgaray, regarding weather-related disruptions north of the border impacting the economy, any sustained slowdown or softer-than-expected growth in the U.S. would have a negative impact on Mexico's growth expectations for 2014.

Unlike some other more developed export-oriented economies, Mexico's internal consumer is not yet sufficiently strong enough to offset the slack from lower exports given low wages and below-average access to financing for most Mexicans; even with recent productivity gains, Mexico's average manufacturing wages are still far below the developing world . A 2012 survey published by the Center for Automotive Research pinned the average wage of Mexican workers in that industry to be about 17% and 13% of their U.S. and German counterparts, respectively.

'A politician that is poor is a poor politician'

Despite recent efforts to clean up endemic corruption that has drawn billions out of the Mexican economy in recent years, these words arguably still hold as true today as they did when master Mexican politician Carlos Hank González, mentor to President Peña Nieto, coined that memorable phrase. Eliminating corruption will remain a key concern for the Peña Nieto administration given the country's complex and confusing permitting scheme, heavy reliance on relationships with third-party intermediaries, and inability of administrative bureaucrats to effectively manage large-scale infrastructure projects that account for about 40% of Mexico's federal budget. For example, according to business consultant Perkins Coie, invoices at state-owned oil giant Petróleos Mexicanos (Pemex) pass through 17 separate steps before payment.

According to Transparency International, Mexico ranks below-average for its region in the most recent Corruption Perception Index, coming in behind such countries as Peru, Brazil, Jamaica, Colombia and Argentina. From our perspective, that perception may benefit from tangible but small steps to increase transparency through measures such as telecom and energy reforms that reduce the role of the state and whittle away at dominating and economy-crippling monopolies.

Nevertheless, we are overall quite constructive on Mexico. Many other countries we follow seem to be in slow-moving denial of the "new normal" for emerging markets, which is characterized by potentially lower commodity prices relative to the last decade as well as more fickle foreign portfolio flows as global quantitative easing comes to an end. Relative to these countries, Mexico stands out as a functional democracy where timely changes and reforms are in the works. Nonetheless, we believe it is quite important to focus on those factors that could potentially derail or delay this "Mexico Moment" and threaten to disappoint markets going forward.

About risk

The performance of an investment concentrated in issuers from Mexico is expected to be closely tied to conditions within Mexico and to be more volatile than more geographically diversified investments.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

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Disclaimer: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

All data provided by Invesco unless otherwise noted.

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