The Mexican presidential election will be held on July 1, 2018. The current frontrunner is left-wing candidate Andrés Manuel López Obrador, but concerns about his agenda and style have impacted markets and sentiment in recent weeks as his lead has widened.
AMLO, the former head of government for Mexico City running with the National Regeneration Movement (MORENA) party, currently enjoys a sizeable lead in polls and his victory is becoming most investors’ base case scenario. Ricardo Anaya, representing a curious coalition of the conservative National Action Party (PAN) and social democrats Party of the Democratic Revolution (PRD) and Citizens’ Movement (MC), trails AMLO in the polls but is ahead of José Antonio Meade, the candidate from the ruling Institutional Revolutionary Party (PRI). Given AMLO’s solid lead in the polls for the presidency, the focus for many Mexico watchers has turned to the congressional election, with MORENA having a good chance of gaining a majority in the lower house. The results of the senate are still hard to predict.
Even if MORENA falls short of a majority in either house, reaching a working majority for AMLO should be straightforward – either with small parties or PRI/PRD legislators that share AMLO’s policy views. Therefore, congress should not pose a barrier in advancing most of AMLO’s agenda, with the exception of constitutional reforms that require 2/3 of the votes in each chamber, we believe.
In our view, Mexico’s current economic situation is reasonably stable, with sound growth, healthy employment and lower inflation. However, the outlook looks less positive as the uncertainty over the trade negotiations and the presidential and congressional election results start to affect expectations, mainly on investment. This has become particularly evident in the past several weeks as AMLO's lead has widened.
Mexico’s GDP increased by 1.1% in the first quarter of 2018, marking the strongest expansion since the third quarter of 2016, mainly driven by gains in services and industry. Higher oil prices, together with the fall in the peso, have boosted manufacturing exports.1
However, looking forward, things don’t look as positive. The Mexico Manufacturing Purchasing Managers Index, a measure of the vitality of the manufacturing sector, fell to 51.0 in May from 51.6 in the previous month, the lowest level since October. Investment continues to be the weak spot, affected by the high degree of uncertainty about the outcome of the ongoing NAFTA negotiations and the elections.2
Politics is the prominent source of uncertainty that is impacting Mexican financial assets. To be sure, emerging markets (EMs), which have been impacted by higher U.S. interest rates and the stronger U.S. dollar, began selling off broadly in late April. Mexican equities had withstood the uncertainty environment fairly well until May when a turning point was reached in terms of risk perception. As of June 8, 2018, the MSCI Mexico IMI 25/50 Index is down 5.4% in local currency terms for the year (but with a 9.5% decline in U.S. dollar terms). In contrast, the MSCI Emerging Markets Index is down 1.2%.3
An AMLO victory could lead to an increase in public investment, which could be beneficial in the short term for growth (although not very positive on inflation). However, those benefits could be mitigated if interest rates go up on the back of fiscal deterioration as the government looks to fund its social program with debt issuance.
Mexican equities and the peso
Source: Thomson Reuters, BlackRock, as of June 11, 2018. Index returns are the MSCI Mexico IMI 25/50 Index in local currency and dollar terms. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
What flows are saying
As we head into the last few weeks of campaigning, flows into single country Mexico exchange traded products (ETPs) have shown bearish investor sentiment, bringing the YTD accumulated flow number to the negative territory, particularly as AMLO's lead has widened.
Following the broader emerging market sell-off in mid-April, investors have overall been withdrawing assets from single country EM ETPs. However, among popular EM exposures, Mexico was one of the only countries that saw sharp outflows in both February and in May. Mexico has particularly fallen behind its Latin American peers.
U.S. listed Latin American single county ETP flows 2018 YTD
Source: Markit, Blackrock, as of 6/11/18
Voters in Mexico (as well as Brazil) currently appear to be favoring candidates outside the traditional political parties in upcoming elections, a change of a trend observed in other Latin American governments (as had been the case in Argentina and Chile), which has increased the concerns of foreign investors. As AMLO’s lead has been widening, his economic policy announcements pose increasing challenges for Mexico’s future fiscal consolidation. However, his particular style could lead to surprises, such as reaching a quicker-than-expected agreement on NAFTA or taking a more moderate policy stance. In any case, Mexico will definitively remain at the center of attention for investors looking toward Latin America.
This post originally appeared on iShares.
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1 Source: Bloomberg, as of June 8, 2018, BlackRock Investment Institute.2 Source: Bloomberg, as of June 8, 2018, BlackRock Investment Institute.3 Source: Thomson Reuters, as of June 11, 2018.
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