EWW: Hawks May Prevail, Alpha Not In The Cards
Summary
- EWW is a rather liquid, large-AUM option to express a bullish sentiment on a cohort of the principally large-size Mexican equities.
- Persistent inflation hints more aggressive rate hikes are in the cards, though this is not necessarily bullish for the peso, as higher rates can trigger a recession.
- Though I appreciate the comfortable valuation of the EWW holdings, I do not believe that is enough to secure consistent gains in case of economic growth grinding to a halt.
- The Hold rating is maintained.
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The iShares MSCI Mexico ETF (NYSEARCA:EWW) is a rather liquid, large-AUM option to express a bullish sentiment on a cohort of the principally large-size Mexican equities, as well as on the national currency, the MXN.
The previous time I shared my thoughts on this passively managed investment vehicle was in February 2021 when I was slightly dissatisfied with its risk/reward profile, assigning it a Hold rating. At the same time, I acknowledged that Mexico's stance on public finances, namely its reluctance to bolster the economy amid the pandemic by means of more spending, should bode well for its national currency in the medium term.
Since the piece was published, EWW has surprised to the upside, delivering a close to 11% price return vs. the S&P 500 remaining almost flat, proving that my view was a bit too conservative; the factors that bolstered returns are the lack of exposure to the richly-valued tech juggernauts that have been bearing the brunt of the higher interest rates dilemma and dragging the tech-heavy indices down, as well as the steady performance of the peso.
Today, I would like to provide an update, incorporating fresh macro considerations in order to arrive at a balanced conclusion on whether the rating on EWW is worth upgrading right now.
The macro picture: expansion faces challenges as inflation bites
In the Q1 report published on June 1, the Bank of Mexico downgraded its 2022 and 2023 GDP growth forecasts, with the 2022 figure now expected to come in the 1.6% - 2.8% range (a 2.2% growth is a base case) and the 2023 assumption being between 1.4% and 3.4% (2.4%). The previous central estimates were higher by 0.2% and 0.5%, respectively.
For a bit better context, the IMF forecast from the April World Economic Outlook specifies a 2% expansion this year followed by 2.5% to be delivered in 2023. These figures have already incorporated the downward adjustments of 0.8% and 0.2%, respectively, from the January 2022 forecast to account for the geopolitical headwinds and their ripple effects, namely in terms of galloping energy costs percolating into prices for almost everything. More data can be found on page 6 of the full report.
Though it looks like a minor downgrade, it should not be ignored since the decline can be exacerbated by higher inflation and subsequently higher interest rates, thus pushing the nation to the brink of a recession.
On June 9, the fresh data on consumer prices were released. The annual core figure touched 7.28% advancing by 59 bps, while the CPI incorporating both energy and food prices was up 18 bps in May to 7.65%. The latter graphically illustrates that though the government is doing its best to alleviate pressure on consumers, subsidizing fuel (diesel and gasoline), it is not that successful in terms of suppressing food inflation, with the meteoric rise of avocados' prices mostly due to the fertilizer market supply/demand imbalances being a vivid example.
To bring slightly more color, it would be pertinent to remark how companies EWW invested in treat the problem of the surging costs. For example, Cemex (CX), one of the leaders in the global cement and aggregates market and the fund's 6th largest investment with a 4% weight, explained in its 1Q22 report that in Mexico, one of its key markets though not the top one, it had been responding to challenges by hiking prices, with the second increase in the price of bagged cement implemented on April 1. The report says the measures "should offset the inflation challenges experienced in the country." However, during the earnings call, the CX CEO acknowledged that inflation raging across the globe still had taken its toll on the consolidated margins despite the double-digit growth in cement prices.
Banxico would prefer a 3% inflation (+/- 1%), and the current level is clearly solidly above the healthy and desirable one. In May, when the overnight interest-rate target was hiked by 50 bps to 7%, notching an eighth consecutive increase since the beginning of the cycle in June 2021, the central bank has already hinted that the upward adjustments would be made if necessary. Put another way, it can opt for a more aggressive step this month, boosting the rate by 75 bps, thus sending it to the level previously seen in 2019.
For the peso, tighter credit conditions in the country are clearly a bullish factor, while again, the risk of going too far and too fast and the prospect of an outright recession are not to be ignored. Besides, scarer capital is a headwind for corporate earnings, thus even with an unchanged earnings multiple of the EWW equity basket (the iShares website shows a rather appealing 11.27x), the share prices could trend down should profits shrink.
Besides, the U.S. has its own inflation issue that has barely abated and the urgent necessity to tight, and this can dent the allure of emerging market bonds that were traditionally viewed as risky high-yield plays, and, inevitably, currencies, with the MXN not being an exception. So, I do not regard the peso as a clear winner of the inflation problem in the country, and thus I am not confident that potentially higher rates at this juncture add to the allure of EWW.
In addition, it merits mentioning that the ETF's price has been trending lower since May 27, and I have a strong reason to consider this retreat as a consequence of the weaker macro assumptions (e.g., the above-mentioned economic report was presented on June 1) percolating into the equity valuations. Besides, the Fed minutes released on May 25, which offered little relief for doves, have probably also contributed.
A closer look at the portfolio
Tracking the MSCI Mexico IMI 25/50 Index, EWW has a portfolio of 43 equities, with the key ten accounting for approximately 63.2% as of June 9. Consumer staples and communications stocks account for the bulk of the net assets, ~29% and ~20.2%, respectively, while the ETF ignores IT and energy completely.
Specifically, investors considering going long EWW should watch the fundamentals of its key holding América Móvil (AMX), a ~$62.3 billion telecom heavyweight, closely since the stock price of the position with a 16% weight can cause remarkable swings in the EWW NAV.
Though the first months of the year were generally successful for it, the selling wave which began in late May has resulted in the AMX price declining ~6.3% on the NYSE, with the relatively strong peso saving it from steeper losses.
On Bolsa Mexicana de Valores, its performance has been softer, with shares down ~9.6% YTD.
As of writing this article, AMX boasts a Strong Buy Quant rating, with the solid Profitability and Momentum being the top contributors to the rating, though EV/Sales, P/B, and the dividend yield are a drag on valuation.
Final thoughts
Among other things, it should be noted that though EWW has rather easily trounced the S&P 500 ETF (IVV) this year after a long period of weak returns, it has underperformed its Latin American peer the iShares MSCI Brazil ETF (EWZ), and its smaller counterpart (EWZS) owning to it having no exposure to the energy sector and also due to the softer performance of the peso compared to the BRL.
At first glance, this is a downside since the Mexico ETF would not benefit in case oil prices remain elevated or even continue galloping. Does that make EWW a weaker EM bet compared to EWZ? Not necessarily. Unlike Brazil, Mexico is not exposed to a political risk of the same magnitude resulting from the uncertainty of the October general election. Apart from that, Brazil's short-term economic growth prospects are already way softer.
In sum, answering the question of whether EWW deserves a rating upgrade, I should flag that with the fresh inflation data published on June 9, the prospects of yet another rate hike and probably a much longer tightening cycle open the door for a recession. Though I appreciate the comfortable valuation of the EWW holdings, I do not believe that is enough to secure consistent gains in case of economic growth grinding to a halt; neither it could protect the NAV from the weaker peso. I should also remind you that the fund has a soft historical risk-adjusted return, with a 10-year Sortino ratio standing at 0.21 vs. IVV's 1.64.
In sum, considering the macro issues discussed above, I maintain the Hold rating.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.