Mexican Reforms Spawn Powerful Economic Force
Mexico gets no respect as an emerging market.
To some extent, though, that’s justified. Even under the conservative governments of 2000 to 2012, the country achieved economic growth of less than 3%. That’s pretty dismal for a middle-income country whose population is growing by 1.2% annually.
However, the government of Enrique Peña Nieto, elected in December 2012, instilled reforms that now seem to be taking effect.
With a business-friendly government, decreasing obstructions to markets in its institutional structure, and excellent free trade treaties, Mexico may be set to surprise us on the upside.
A History of Not-so-Free Markets
Mexico hasn’t really been a free-market country since the glory days of Porfirio Díaz (1876 to 1911). Indeed, the Mexican Revolution that followed Díaz was socialist-inspired and bitterly opposed to the wealthy elite who had prospered in previous decades.
Meanwhile, the Institutional Revolutionary Party (PRI) governments of 1929 to 2000 nationalized the oil industry and imposed a huge mass of conflicting regulations on the economy. In 1981, a Mexican CEO (for whom I did a bond issue) said to me, “This economy is a triumph of Joan Robinson economics.”
Robinson, a Cambridge left-socialist economist (1903-83), had recommended that the state make the main economic decisions – including setting prices. 1981 Mexico represented her theories, but the economic collapse of the following year showed how badly they worked in practice.
Afterward, there was a partial liberalization under the PRI governments of 1982 to 2000, although it was largely dominated by crony capitalism. A famous example is the “privatization” of the telephone monopoly Telmex to Carlos Slim, who became the world’s richest man from its profits.
Finally, reform was expected when the conservative opposition PAN candidates won the 2000 and 2006 elections – but it never happened. Economic stagnation continued despite access to the U.S. market following the 1994 North American Free Trade Agreement (NAFTA), and productivity performance was especially poor. It grew just 0.3% per annum in 2007 to 2014, according to The Conference Board’s Total Economy Database.
Today, though, all of this appears to be changing.
In addition to opening up the telephone business, Peña Nieto has made at least modest reforms to Mexico’s dreadful, union-dominated education system.
He also opened Mexican oil leases to foreign bidders, which had previously been banned by the Mexican Expropriation of Foreign Oil in 1938. Of course, in a fitting example of Murphy’s Law, bidding has been permitted just as oil prices have dropped.
Indeed, the national oil company, Pemex, made a record loss of $6.4 billion in the first quarter, with production down 7.7% from the previous year, continuing a 10-year record of decline. And, since Mexico’s budget relies heavily on revenue from Pemex, the budget balance has been thrown for a loop.
Still, Mexico’s overall prospects for 2015 to 2016 look considerably improved, with the International Monetary Fund forecasting average growth of 3.2%. Meanwhile, the projected balance of payments deficit is modest at 2.3% of GDP – easily financeable even if a credit crunch occurs.
Most importantly, the long-term favorable factors remain. For one thing, Mexico has free trade agreements with a whopping 44 countries. That’s four times as many as Brazil, according to the Financial Times.
So, if you’d like to take advantage of this unloved nation, here are a few ideas for how to invest in Mexico…
First is the iShares MSCI Mexico Capped ETF (EWW), a $1.9-billion ETF that’s trading at 18x earnings and yielding 1.3%. Because it’s linked to the MSCI Index, EWW gives you a broad spread of Mexican holdings. And since it’s capped, it doesn’t overweight you in the big-cap America Movil (AMX), which is controlled by Carlos Slim. Finally, it boasts an affordable expense ratio of just 0.48%.
A particular favorite of mine is Industrias Bachoco S.A.B. de C.V. (IBA), a poultry farming combine based in Guanajuato province. Because of NAFTA, Bachoco has access to the U.S. market, where it makes about one-third of its sales. It also has the advantage of considerably lower labor costs than competitors, such as Tyson Foods (TSN), in a labor-intensive business. IBA is currently trading at a forward P/E of a mere 10.5x and has a decent dividend yield of 2.1%.
Lastly, Grupo Simec SAB de CV (SIM) is a specialty steel manufacturer based in Guadalajara. Like IBA, SIM is reasonably priced, trading at 11.4x forecast 2015 earnings, although it doesn’t pay a dividend. Encouragingly, the company’s first-quarter net income was up 35% from the previous year.