Mexico’s Bull Run

Despite the antics, the atavistic fondness for state intervention and control, and the frequent attacks on both local and foreign business interests, Mexico’s populist leader Andres Manuel Lopes Obrador (AMLO) is presiding over the country’s best financial markets  in years.

AMLO can be credited for a sound fiscal policy and for letting the orthodox  Central Bank  do its job. This hasn’t resulted in better economic growth but it has allowed for a more stable economy than most of Mexico’s peers around emerging markets. However, the main cause for market enthusiasm seems to be the hope that Mexico will be a major beneficiary of  “friend-shoring” investments, as global manufacturers look for ways to diversify away from China.

The performance of Mexican assets has been remarkable. As shown below, the Mexican peso is the strongest currency in the world for the past one and three years,  periods marked by considerable chaos in currency markets in many other emerging markets

The Mexican stock market also has done exceptionally well, as shown in the chart below. The Bolsa is a top performer for both the past one and three years. For the past five years it is near the top, surpassed mainly by tech-heavy markets (U.S., Taiwan,  Netherlands, Denmark). This is impressive given that Mexico does not have a tech sector.

The current sectorial composition of the Mexican market relative to other markets is shown below.  A characteristic of the Mexican market is the high weight of defensive stocks, mainly consumer oriented telecom, food and retailing businesses. Unlike in most other emerging markets, the Bolsa is not dominated by state companies or mature cyclicals, but rather by well managed private concerns. The combination of a stable economy and well-managed private companies is a rarity in emerging markets.

The ten largest stocks in the MSCI Mexico index are listed below. With the possible exceptions of Banorte and Cemex, these are profitable world class companies with dominant market positions, all trading at near all-time high stock prices.

After this impressive bull run, what are the prospects for the Mexican market?

It should be noted that both the currency and stock prices started this run at low levels in both relative and absolute terms. As the chart below shows, Mexico’s Real Effective Exchange Rate was at historically low levels in 2019, and it remains competitive today. Over the past 20 years the peso has been managed like an Asian currency, for stability and export competitiveness. The Brazilian REER,  shown for contrast, is much more volatile, which causes havoc for managing the current account and promoting manufacturing exports.

 

The next chart shows that the cyclically-adjusted price earnings ratio (CAPE)  for Mexico was at historically low levels in 2019, and the PE ratio was well below trend. The CAPE ratio has now normalized but is still far from stretched.

Mexico’s CAPE ratio based on expected earnings for 2023 is currently at 17.2 which is in line with the country’s average for the past three decades. As shown below, based on historical returns, prospects for future seven- and ten-year returns are moderately positive.

 

Bull runs are not usually stopped by valuation concerns. Along with India, Mexico may continue to be one of the few large emerging market with a credible narrative and the capacity to absorb foreign capital. Nevertheless, in coming years, investors will need to see “Friend-shoring” capital flows go from hope to reality to sustain the Mexico story.