2nd April 2013
Mexico’s stock market has the brightest future it has had in years, argues J.P. Morgan Asset Management.
In a note issued today (2 April), Dan Morris, Global Strategist at J.P. Morgan Asset Management argues that political reforms look set to liberalise the economy confounding some pessimists who had worried that that the election of Enrique Peña Nieto to Mexico’s presidency could herald a return to the past.
Morris says: “As leader of the PRI (Partido Revolucionario Institucional), which ruled Mexico for over 70 years, many feared he would reinstate the party’s traditionally protectionist policies. Instead he has surprised since his inauguration in December by promising to liberalise the economy, to foster greater competition in protected industries and even to open up the country’s state-controlled oil industry to outside investment.”
Comparing the recent performance of Japan and Mexico, Morris points out that the two markets have performed very differently recently.
“The reaction of the markets to the changes in the two countries, however, has been very different. Since global equity markets bottomed in March 2009, Mexico has outperformed the broad MSCI All Country World Index (ACWI), the US and Brazil. But it has underperformed recently. Japan’s equity index has gained 44 per cent since mid-November while Mexico’s has advanced just 8 per cent, less than the 15 per cent return on the ACWI (price change in local currency terms)”.
However the challenges facing Mexico and Japan are starkly different.
Morris says: “The challenges facing the two countries are, of course, quite different and the responses in Mexico may only generate returns later on (and some may even hurt in the short-term). For example, the Mexican government hopes to improve the ossified education system, which ranks below average according to the OECD’s Program for International Student Assessment (PISA). The recent arrest of the previously untouchable head of the teachers union, who had been in place for 23 years, indicates the government’s determination, but it will be years before the economy benefits.”
The Mexican equity market does face some structural challenges including the fact it is less diverse than some of its regional neighbours. Morris says: “While the market capitalisation of the MSCI index is roughly the same size relative to GDP as it is for Brazil, it is not as diverse. Brazil’s main index has 81 members with all the main sectors represented, but Mexico’s index has only 26 members and four sectors have no listings at all: energy, health care, information technology and utilities. The lack of members in the energy and utilities sectors is all the more surprising given that Mexico is a major oil producer. The government’s intent to liberalise the energy sector — though stopping short of even partly privatising national oil producer Pemex — is one of its greatest challenges, but also the one that offers the greatest opportunity for development of the economy and the stock market in the future.”
The note also points out the reluctance of Mexican banks to change though this may again change with the financial crisis.
“The underweight of the financial sector relative to global markets highlights the comparatively small role the banking sector plays in the country. Due to a previous financial crisis, the banking sector is reluctant to lend (not so different from Europe, in fact). Though the crisis occurred years ago, private sector credit today represents just 26 per cent of GDP compared to 61 per cent for Brazil (last data from 2011). This is another area where the government wants to see change. Though the benefits for the economy may take time to appear, expectations for profitability in the banking sector are already beginning to rise.”
“In the same way that the country’s political landscape was monopolised for many years by one party, parts of the economy have been dominated by a few companies, in particular in the telecommunications and media sectors. The government has vowed to open them up to more competition. While this will help the economy it will also lower returns for the existing players. While earnings forecasts for the market overall are quite strong, those for telecommunications, for example, have dropped dramatically. The parallel drop in prices for some of these companies explains much of the index’s recent poor performance.”
Morris concludes: “The future for Mexico’s economy is the brightest it’s appeared in years, but to profit from it investors will need to do more than just track the index. Look to future IPOs and non-dominant companies in currently mono- or oligopolised sectors to realise the potential.”