Entering text into the input field will update the search result below

Número Um Or Número Uno?

Apr. 21, 2015 9:23 AM ET
Oisin Breen profile picture
Oisin Breen's Blog
806 Followers
Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Aside from Canada and the United States, two other leading economies in the Americas are Brazil and Mexico. Global economic conditions have affected both. Is one of the two a setting sun and the other a rising star?

Mexico has an envious geo-economic position of sharing its northern land border with the world's largest economy, the United States. It has both Pacific and Gulf of Mexico ports hence direct sea lanes to Europe as well as the world's second and third largest economies, China and Japan. On its southern border Mexico has access to the south via a land bridge through the Isthmus of Panama although its costal ports make its use unnecessary. Geographically, Mexico stands at the crossroad of the world's sea lane traffic.

Mexico is a signatory of the North American Free Trade Agreement under which it trades 90% of its exports and 55% of its imports with the United States. This accounts for almost 80% of all its trade totaling $507 billion USD. In addition, it's signatory to the Asia-Pacific Economic Cooperation agreement and Trans Pacific Partnership accord. It's a member of the WTO as well as the OECD. With a nearly $1.3 trillion USD GDP, equivalent to $2.1 USD trillion in purchasing power parity, it places 15th as a world economy and 11th in PPP. Per capita income by 2014 estimate is $17,700. Gross national savings, which include personal, business and government surpluses, are nearly 20% of GDP. Income distribution is extremely unequal and it's estimated that over 52% of its population is below the poverty level.

Democratically elected administrations have reined in inflation and privatized state owned industries including telecommunication, power generation, ports, transportation and the petroleum industry. The reforms of President Peña Nieto's administration have placed Mexico squarely on track towards becoming an industrial economy. Corruption has been reduced and consequently the power of the drug cartels. Industrial production accounts for 35% of GDP and services account for 60%. It should be noted that agriculture accounts for only 3.5% of GDP but an ongoing drought in California, which accounts for 50% US produce, opens a door to a market for its agricultural products. Petroleum production accounts for a large part of Mexican Government's revenues; however Mexico is not a petro-economy. The decline in oil prices has affected the Mexican economy but only as much as global economic conditions in general. Because of the economic ties with the United States, lower priced Mexican petroleum exports keep US fuel prices in check, thus increasing US consumer spending power. Since over 75% of Mexico's exports are to the US retail sector, lower oil revenues are offset by US consumer demand. Aircraft and Automobile research, design, development is a major component of its industrial sector as well as having globally recognized quality manufacturing of each. Mexico ranks sixth globally in electronics manufacturing and the sector is growing at a double digit rate. Mexico's private banking sector is well capitalized, profitable and well integrated with international financial institutions. Its equities market is second only to Brazil.

On 9 April, the five member board of the Bank of Mexico unanimously agreed to leave its overnight lending target rate unchanged at 3%. Expectations for 2015 GDP growth range from 3.2% to 3.5%. It should be noted that central bank reforms were instituted after the infamous sovereign bond crash in 1994. These reforms include a policy for the accumulation of foreign currency reserves through oil export revenues, as well policy tools on par with advanced economy central banking standards. The mandate for Banco de México is to maintain the purchasing power of the Peso.

According to the IMF, Mexico's public debt is 36.9% of GDP. Mexico often issues debt in foreign currencies as well as in pesos. The 3.23% yield on its 10 year bond makes it attractive to fixed yield investors. Other debt has been issued in Japanese Yen, US Dollars and the Euro. Mexico has recently issued a 100 year Euro bond at 4.50%; S&P rated BBB+.

Brazil, on the other hand, has an enormous landmass and shares borders with all but two countries on the South American continent. It does not have the advantage of Pacific ports. Its main import/export partners are China, the US and Argentina in that order. 16% of its trade amounting to $80 billion is with China. Brazil is a member of the WTO, the G-20 and MERCOSUR, (a South American Free trade organization) and the Union of South American Nations. Brazil is currently in the process of establishing free trade agreements with India and South Africa. Trade barriers have been an obstacle to the United States as well as the EU. According the European Commission, Brazil is the EU's first trade partner accounting for 21% of the EU's total trade, however the commission also notes high tariffs, averaging 13.5%, as an obstacle to trade.

Brazil's economy is approximately 1/3 larger than Mexico. Its 2014 GDP was estimated at approximately $2.25 trillion USD, ranking it 8th in nominal terms, equivalent to $3.59 USD trillion in purchasing power parity ranking it 7th. Weak global demand weighed heavily on the 2014 economy resulting in GDP growth of merely 0.15%. Expectation for 2015 GDP growth has been reduced to 0.5% from 0.9% according to Finance Minister Joaquim Levy. Private sector estimates are lower. It's not unreasonable to assume that poor GDP growth is due to slower Chinese demand for iron ore and soybean. In addition, there is competition in the shrinking iron ore market, for example by Australia, also a major commodity trade partner for China. Finance Minister Levy has discounted slowing global economies and expects both ECB and PBOC QE programs to increase demand for Brazilian exports. In order to make up for lost revenue the government has raised taxes on consumer retail products, across the board. Further complicating matters, Brazil, too, is experiencing a drought. 5.8% of GDP depends on agriculture, a major export and there's a looming possibility of electricity rationing. Rationing could affect industrial production, which accounts for almost 22% of GDP. Brazil's per capita income by 2014 estimates is $15,200. It is estimated that nearly 22% of Brazilians are below the poverty line

and income distribution is uneven.

This past March, Banco Central do Brasil (Brazil's central bank), raised its overnight lending rate to 12.75%, a 50 basis point increase and a 100 basis point increase year to date. The BCOB is trying to reduce an 8.00% inflation rate to a 4.5% inflation target. Over the past 52 weeks the Real has lost 25% of its value. In brief, Brazil's currency, the Real is losing purchasing power at a time when the economy is shrinking and taxes are increasing.

Brazil's debt to GDP is 56.8%. Its benchmark 10 year bond yields 4.32% and S&P rated at BBB-. In the private sector a recent widespread corruption scandal involving the energy company Petrobras was revealed, and although uncovered by government investigators, it cast suspicion over the government and the entire bond sector. Because of the scandal, demand for Brazilian issuances fell, so much so a scheduled sovereign debt sale was cancelled. The total Brazilian bond market accounts for about 30% of all South American bond issuances. It should also be noted that Brazil also issues its sovereign bonds denominated in US Dollars and Euros.

Although it may seem tempting to call a bottom for the Brazilian economy, the lesser risk seems to be with the Mexican economy. The strength behind Mexico is due to its neighbors to the north. Should the US economy strengthen it will affect the Mexican economy more than the Brazilian economy. Even if the US economy continues to plod along, it will take Mexican economy along with it. Further, the US is an economic competitor with China. Trade agreements made in the Pacific region, for example the Trans Pacific Partnership, will have a positive effect for Mexico both directly and indirectly whereas Brazil is more affected by the EU and Chinese economies. This is especially true for Brazil's commodity and agricultural exports. Even if the Chinese economy regains some momentum, it already has ample stockpiles of industrial commodities and also has competing agreements with its Australian trading partner. The EU is a major importer of Brazilian agricultural products but the combination of drought and trade barriers might restrict supply in spite of a weak Brazilian currency.

Key Comparisons

Brazil

Mexico

Currency

Real - 8.00% inflation rate

Peso-4.36% inflation rate

Expected 2014 GDP growth

0.0% to 0.5%

3.2% to 3.5%

Debt to GDP

56.8%

36.9%

Major Exports

Iron ore, Agriculture, Automobiles, Lumber

Automobiles, Electronics, Oil, Aerospace

Overnight Lending Target

12.75%

3.0%

Sovereign Debt S&P Rating

BBB- / Stable

BBB+ / Stable

GDP PPP

$3.59 Trillion

$2.143 Trillion

Investors should carefully examine regional emerging ETF exposure to Brazil and Mexico and adjust accordingly. Investor should also weigh out where the best potential return with the least risk is in the America's emerging market economies. It seems that, presently, the Brazilian economy might not live up to its expectations for the foreseeable future, whereas the Mexican economy is on track to exceed its expectations.

Sources: CIA Fact Book, OECD, Wall Street Journal, Forbes

"CFDs, spread betting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk."

Analyst's Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author has neither Mexican nor Brazil ETF holdings, nor derivative products, nor currency positions.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Recommended For You