Today we are looking at a newly issued five-year Morgan Stanley (MS) Mexican peso bond that will yield 6.0 the first three years, and then step up to 7.25% in years four and five. The high yield and medium length maturity of this Mexican peso denominated bond, when considered with its solid A3/A- rating, compares very favorably with other high-yielding instruments in our Foreign and World Fixed Income Holdings. We believe the dollar's longer-term weakening trend against many world currencies remains a major concern for investors seeking protection against its devaluation and a further erosion of its buying power. We view this as an opportune time to increase our exposure to a currency that we think has one of the better potentials to appreciate.
Wealth Preservation and U.S. Dollar Concerns
With both domestic and emerging market bond yields continuing to sink amid the current global economic uncertainty, wealth preservation remains a top priority for many people. Declining equity and property prices, ultra-low interest rates, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the Fed's easy money policies continue to precipitate a widespread erosion of wealth that will likely continue until the aforementioned conditions begin to change. Consequently, we are continuing with our efforts to stay ahead of this destruction of wealth by searching the globe for the highest fixed income opportunities exceeding our stringent criteria of lower risk relative to its potential for positively accruing returns.
The economy of Mexico is the 13th largest in the world in nominal terms and the 11th largest in terms of purchasing power parity, according to the World Bank. The United Nations reports that Mexico's standard of living -- including health, education, and per capita income -- is now higher than Russia, China, and India. As an export-oriented economy in the trillion-dollar class, it remains integrally correlated to the U.S. economy because of its prominent role at 80% of exports trading partner. However, Mexico's last reported debt-to-GDP ratio grew by only 1.9% compared to the end of 2011, and now stands at the equivalent of 33.6% of GDP, compared to the U.S. ratio well over three times that, having now passed 100%. Mexico's Finance Department says the country's economy grew by 4% in the second quarter of the year as compared to the same period of 2011, and unemployment is about 4.97% compared to 8.6% for the U.S.
The Bank of Mexico kept its main policy rate unchanged at 4.5% in July -- its stance for the past three years -- but signaled the outlook for the country's economy appears to be weakening as global growth slows. Many analysts expect the bank to keep rates on hold at least until early next year. The annual rate of inflation in Mexico accelerated to 4.45% in early July from 4.34% at the end of June, but annual inflation is expected to slow to below 4% by the year-end, as recent increases in some food prices should prove temporary.
Given these healthy domestic economic fundamentals and the improved U.S. growth prospects, the low direct exposure of the peso to European stress, the recent upward bias in crude oil prices, and the peso's undervaluation vs. its longer term fair-value metrics, we think the Mexican peso is poised to potentially outperform the U.S. dollar relative to other world currencies.
About Morgan Stanley
After the Glass-Steagall Act of 1933, which separated commercial banking from securities underwriting, Morgan Stanley opened for business after separating from JPMorgan (JPM). When the global financial crisis of 2008 brought down rivals Bear Stearns and Lehman Brothers, Morgan Stanley secured a $9 billion capital investment from Mitsubishi UFJ (MTU). The firm also helped the U.S. Treasury navigate the crisis at mortgage providers Fannie Mae (FNMA) and Freddie Mac (FMCC). In 2009, James Gorman helped create the largest wealth management platform in the world when he led the merger and integration of Morgan Stanley's retail brokerage operations and Citibank's Smith Barney brokerage unit. The wealth management platform is a very good annuitized income, lower-risk business. The Morgan Stanley Smith Barney joint venture is now a global leader with more than 18,000 financial advisors and $1.5 trillion in client assets.
Morgan Stanley delivered strong full-year results, reporting fourth quarter net revenues at $5.7 billion and full-year net revenues for 2011 at $32.4 billion. The Global Wealth Management Group delivered net revenues of $13.4 billion, with global fee-based asset flows of $42.5 billion and net new assets of $35.8 billion, the highest for both since the inception of the Morgan Stanley Smith Barney joint venture (MSSB). The year's pre-tax margin improved to 10% from 9% a year ago. Asset Management reported net revenues of $1.9 billion, with assets under management or supervision of $287 billion and positive net flows of $25.8 billion. In strategic actions that further strengthen Morgan Stanley's capital and liquidity, its Series B Preferred Stock held by MUFG was converted into common stock, and several outstanding strategic and legacy issues were resolved, including a settlement with MBIA.
Five-Year Bond Yield
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This Morgan Stanley Mexican peso bond indicates an average yield over 7 times greater that similar maturity U.S. Treasuries, and a yield that is about 40% greater that of similar Morgan Stanley bonds denominated in U.S. dollars. Even if the Congressional Budget office is wrong and we have strong appreciation in the dollar, as long as the currency appreciation averages less than 2% annually relative to the peso, this bond would perform about the same as its U.S. dollar counterpart. However, if the head of Mexico's central bank is correct in its assessment that the peso's current exchange rate doesn't accurately reflect the strength of the Mexican economy and that the currency has room to appreciate, any appreciation of the peso will be added to this debt instrument's returns.
Please compare this Mexican peso linked Morgan Stanley Bond to other offshore bank income investment opportunites, that include Morgan Stanley's Brazilian real linked, or Bank of America (BAC)'s Brazilian real bond and Australian dollar bonds of shorter maturities.
The default risk is Morgan Stanley's ability to perform. Given last year's great results, its improved balance sheet, and the positive outlook for Morgan Stanley, it is our opinion that the default risk for this short-term bond is minimal relative to the currency risk of the Mexican peso. The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to Mexico's economy.
Per capita income in Mexico is roughly one-third that of the U.S., and income distribution remains highly unequal. The current Mexican administration continues to face many economic challenges, including improving the public education system, upgrading infrastructure, modernizing labor laws, and fostering private investment in the energy sector. Because of the dominance of exports to the U.S., its economy will remain correlated to that of the U.S.
Accessibility and Liquidity
Morgan Stanley currently has over $415 billion of outstanding debt, mainly denominated in U.S. dollars. Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, the question arises as to how a retail investor might own or acquire individual, maturity definite Morgan Stanley Russian Mexican peso bonds. Many times broker/dealers require an institutional-sized single bond purchase. However, with a broker and advisor's assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional-sized purchase. Previously, we have been able to facilitate purchases as low as U.S. $10,000.
Despite the dollar's remarkably strong performance this year, largely the effect of broad global concerns stemming from the European debt crisis, the era of dollar devaluation and "easy money" from the Fed appears to be far from being over. Regardless of how opaque the economic "stimulus" reasoning is, or how it is presented to the average American citizen as being vital and necessary for our economy, the global economy dependence on the dollar, and the dollar's dominant position as the reserve currency of the world continues to be challenged. However, we believe that diversification into higher yielding corporate debt instruments denominated in foreign currencies poised to strengthen relative to the dollar offer a savvy hedge against what some might view as an inevitable devaluation of the U.S. dollar.
As a result, it is our opinion that this short-term, higher-yielding investment grade Mexican peso bond, issued by a sound and well respected financial institution, provides an intelligent alternative to the U.S. dollar's further devaluation and loss of buying power, which is why we have added it to our Foreign and World Fixed Income holdings.
Coupon: 6.0%, steps up to 7.25 after three years
Matures: Aug. 22, 2017
Ranking: SR UNSECURED
Disclaimer: Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports.