Shore Up With Mexico
Portfolio Manager John Paul Lech explains why he believes Mexico presents good opportunities in volatile markets particularly as corporates start to diversify their supply chains.
What are the top-down strengths of Mexico?
Mexico plays a strategic role in the global economy. The country is one of only a handful of emerging markets with an investment grade sovereign-debt rating. It is the 15th-largest economy in the world, with a gross domestic product (GDP) exceeding $1 trillion and a substantial manufacturing base. More importantly, Mexico shares a 3,000-plus kilometer border with the U.S., the world’s biggest consumption market.
Mexico is not a commodity driven economy but its budget does benefit from high oil prices. Like most emerging markets, Mexico’s institutions have their shortcomings, however, the country scores quite well comparatively for the purposes of assessing portfolio and foreign direct investment. Mexico has one of the oldest independent central banks in the developing world and the national currency is fully convertible.
In terms of economic activity, Mexico’s headline GDP is not spectacular. However, the country has robust exports in electronics, autos, aerospace and other manufacturing and it has the potential to grow further as companies look to cut costs by diversifying their supply chains. Consumption and national accounts are buoyed by record high remittances that are running above an annualized $50 billion. Tourism is also a key contributor to Mexico’s economy and, as any recent traveler can visually discern, traffic at many major airport hubs is already surpassing pre-pandemic levels.
Tailwinds and headwinds
Mexico’s strengths and weaknesses as an emerging market portfolio-growth driver.
How will Mexico steer a course through inflationary headwinds?
Mexico is experiencing high inflation like much of the world. The success of the government’s collaboration with the private sector to maintain stable prices on key items is debatable. That said, the central bank’s willingness to run tight monetary policy to combat inflation doesn’t appear in doubt. Mexico’s monetary policy has often tracked that of the U.S. Federal Reserve quite closely and we expect this to continue during the current Fed’s tightening cycle. In essence, Mexico will likely seek to ensure its key short-term rates maintain a robust spread over the U.S. Fed Funds rate.
What are the attractive opportunities in Mexico’s markets?
Mexico has solid business sectors but its capital markets aren’t particularly deep. Many businesses are private and unlisted. Mexico’s exporters, for example, are often not directly investable. Companies that generate the majority of activity in autos, aerospace and electronics are often the local subsidiaries of global firms and thus aren’t listed on the local stock market. And while tourism is a huge sector, hotels and tour operators aren’t very accessible via public markets.
Growth opportunities for portfolio investors often come indirectly. It can come from an airport concessionaire that is a beneficiary from tourism. It can come from a commercial bank where activity has high gearing towards more dynamic parts of the economy. It can also come from real estate investment trusts (REITs)—like companies specialized in logistics or manufacturing facilities which are strong indirect beneficiaries of manufacturing and export activity.
Mexico’s culture is one of its key attractions for tourists but this is also big business. Most Americans, for example, will be familiar with tequila which is only produced in Mexico. Tequila spans the gamut from relatively cheap to ultra-premium. Like most spirits, it’s the high end of the market that is driving growth as consumers become connoisseurs who are increasingly willing to pay up for quality and perceived prestige. The key ingredient in tequila comes from the blue agave plant and unlike grains used in rum, vodka or other spirits, agave is not a major foodstuff. It’s therefore not experiencing the inflationary pressures that most grains are. That’s making tequila a rare product in the food and beverage space because its growing in popularity and without the severe margin pressure faced by many purveyors of food and beverages.
How will Mexico benefit from new supply-chain networks?
Supply-chain networks have been diversifying for some time. China’s labor costs have been rising from well before the pandemic and stricter standards and more capital-intensive manufacturing has meant a shrinking cost advantage relative to other markets. The country’s zero-COVID policy, which has resulted in city-wide lockdowns of key manufacturing areas, has become catalytic to the supply-chain diversifying trend. While it will take time, supply chains are becoming multipolar spurred by not only costs but issues like transportation expenses, trade agreements, geopolitics and a desire for multi-national companies (MNCs) to have multiple sources of supply on a “just in case” foundation.
This backdrop is supportive for Mexico. Businesses from around the world are attracted to it due to its proximity to the U.S. and Canadian markets, and to its favored access via the U.S.-Mexico-Canada-Agreement (USMCA)—the successor to the better known North American Free Trade Agreement (NAFTA). Higher energy costs and Environmental, Social and Governance (ESG) concerns on carbon emissions by some manufacturers also augur in favor of firms placing manufacturing closer to end demand.
Anecdotal evidence of increased nearshoring in Mexico is easy to find but hard data isn’t. We are in the early days. However, one indicator is the fact that logistics and warehouse vacancy rates are at a decade-plus low nationally, and the northern part of the country has very little available facilities.
Will nearshoring be near-term or long-term?
Nearshoring could be a theme that impacts Mexico over longer durations of time. The world will remain globally interconnected but the next 20 years might look different from the past two decades. It’s quite plausible to see more localized blocs of production. As a member of free-trade agreements and an economy with wide-ranging industrial capability, Mexico is in a good position to potentially benefit from companies diversifying supply chains and logistics. In the years ahead, we see a wide range of business sectors gaining from this, including health care, technology, aerospace and pharmaceuticals.
John Paul Lech
Environmental, Social and Governance (ESG): ESG is a set of standards used by socially conscious investors to screen potential investments.
Gross Domestic Product (GDP): GDP is the total value of goods produced and services provided in a country during one year.
Real Estate Investment Trusts (REITs): REITS are companies that own, operate, or finance income-generating property.