Our last call on the iShares MSCI Mexico ETF (NYSEARCA:EWW) was a good one. Dollarization and staple exposures kept EWW above water and outperforming the market by 20% as of today. While we still like the staple exposures, we point out that dollarization exposes many of the stocks that rely on income in MXP to suffer together with the dollar in a peak rate scenario. While it's still a debate whether or not current inflation is structural and that higher rates will be permanent, in either case, the upside is becoming more limited with EWW.
Consumer staples is still the biggest exposure within the portfolio at 30%. This includes Mexican Walmart, Fomento (FMX) which is a Coca-Cola (KO) bottling company, as well as Grupo Bimbo (OTCPK:GRBMF) which is a consumer brands company and also stocks like Bachoco (IBA) which sells chicken products and rears chicken.
The other major sectoral exposures are banking, so positively levered to interest rate increases, not so much to recession which would reduce loan growth. Other than that, there's major exposure to communication, primarily to America Movil (AMX) which is the region's telecoms company, which is resilient, and not especially levered in either direction of the economy.
The reason we are commenting on EWW now has to do with the idea that we may be arriving at a peak inflation moment. There are several reasons we think this could be possible and may take the market by surprise. So far, the current inflation we are seeing is consistent with the wealth destruction that comes with foreign economies being comparatively more levered to oil where oil has become more valuable with the Russian sanctions. Second, we no longer have a chip shortage, we have the opposite - indeed shortages aren't really such a problem anymore. Finally, the key logistic bottleneck is loosening judging by shortening charters and rapidly falling rates even in containership charters, but especially in dry bulk consistent with a worsening commodity environment. Real wages are also falling, so no wage-price inflation spiral yet.
If inflation peaks then rates will likely peak too, because they are for now considered by the Fed as a necessary evil - although perhaps the Fed believes inflation is actually still more or less transitory; but it is responding to it in case they'd be accused of shirking their duty again. If rates peak, it's not the greatest for financial exposures like those in EWW and it wouldn't really mean much one way or another for the staples exposures which have done well, indeed EWW is up 3% YTD. Finally, it's not great for the Mexican Peso. A lot of EWW exposures have local markets. There's been no currency headwind yet from the dollar and the peso exposures within, but for the international investor, if the dollar falls there are better places to park money on currency effects that have been a major tailwind for many businesses. The MXP and the USD are very interlinked due to the extensive trade that happens between the nations. The currencies are effectively symbiotic. While it's possible that the dollar stays strong, the major leverage the dollar and in turn the peso have had is that the dollar is the reserve currency and is extra attractive with higher risk-free rates. If those reverse or there is promise for those to reverse, EWW will lose out in the increment compared to other plays that will be more poised for recovery.
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