Market analysis: Mexico leads the pack among emerging markets

Mexico has developed into a high-value-added exporting powerhouse to the United States, writes Rodolfo Ramos Cevallos.

Mexico is the seventh-largest car manufacturer in the world and the largest supplier of car parts to the US. Shizuo Kambayashi / AP Photo

While last year was a challenging environment for investors – including those in Mexico – we think Mexico stands out from many other countries in Latin America, and as well as other emerging markets, for a number of reasons.

Mexico has developed into a high-value-added exporting powerhouse to the United States. It has passed structural reforms geared to encourage competition and attract investments at a time, when most countries are shying away from private investment and liberalisation, and it has stable fiscal and macroeconomic management.

Because of this differentiation, Mexico’s equity market has been able to outperform broader Latin America as well as emerging markets overall (as measured by MSCI indexes) in the past one, three and five-year periods.

Currently, we are seeing opportunities in the export sector. The car industry is a good example; Mexico is the seventh-largest car manufacturer in the world and the largest supplier of car parts to the US.

We also see bargains in the mining sector. While it has been out of favour in recent years, we have been able to find cost-competitive companies in Mexico with solid balance sheets that appear well-positioned to pot­entially benefit when the cycle turns.

Within Mexico, we are also finding opportunities in the banking and financial services sectors. Overall loan penetration in Mexico currently stands among the lowest in all of Latin America, and we believe financial services companies should do well as new industries such as energy and oil are listed and monetised in the equity market.

The Mexican peso is one of the most liquid currencies in the world and in emerging markets. A large derivatives market also drives currency prices. The peso has historically been correlated with oil prices because of Mexico’s oil assets and the government’s dependence on them for tax revenues.

These dynamics pushed the peso to an all-time low versus the US dollar at the beginning of the year. The peso’s dismal performance has been a major area of frustration and concern for global investors, especially considering Mexico’s stable macroeconomic outlook.

Monetary policy is coordinated between the US Federal Reserve and its Mexican counterpart, which should limit any adverse impact from a tightening cycle in US monetary conditions.

We do not foresee a material impact on Mexico’s economy from a gradual increase in interest rates in the US.

While oil is meaningful to the Mexican government in terms of revenue, it actually only represents 10 per cent of its exports. Oil’s contribution to the federal budget has dropped by half in the past couple of years from about 40 per cent in 2008 to about 20 per cent last year. Unfortunately, consumers have generally not seen lower prices at the pump yet, but with the liberalisation of the oil sector that could change in the coming years.

Throughout Latin America, governments can no longer rely on high commodity prices to help them finance key programmes and projects.

Energy reform in Mexico has opened up the oil sector to private investment through different participation schemes. Previously, the state-owned enterprise Pemex was the only firm that was allowed to capitalise on oil resources. Now, the newly established National Hydrocarbons Commission has the authority to auction fields to private parties.

The government is currently working on the rules governing the Mexican equivalent of a US master limited partnership that will be used to list energy assets from Pemex and private parties. We believe all of these developments are likely to lead to an increase in foreign direct investment.

Telecommunications has been another key area of reform, which has encouraged competition with the creation of an independent regulator. Telecommunications prices have dramatically declined since the reform’s implementation, translating into a direct saving to consumers.

The Mexican economy has been improving in a number of areas. Consumption has been strong, and the government has been proactive in announcing cuts as well as relying more on private investment to finance projects. Short-term market jitters aside, the US economy still looks strong, which should help Mexico going forward and make it an attractive place to invest.

Rodolfo Ramos Cevallos is a vice president and investment analyst at Templeton Emerging Markets Group