In 2012, financial news has been dominated by Europe, China and the US—with the eurozone’s troubles, China’s economic wobbling and the US’s looming “fiscal cliff,” investors are hyper focused on these areas and how they could impact global stocks. Meanwhile, more impactful developments have flown under the radar. One example: Mexican stocks have performed amazingly well in 2012, more than doubling global and Emerging Markets returns. Here, Fisher Investments reviews the forces driving Mexican shares and the outlook from here.
Mexico has one big, innate advantage: geography. Because of its shared border with the US—and more importantly, mostly free trade across that shared border—it has strong trade and investment ties with American firms. As a result, Mexican stocks tend to do well when the US does well. At the moment, the US economy is growing, and consumer demand is strong. Corporations are also healthy, growing and flush with cash—fodder for future growth in the end-market for 80% of Mexican exports.
Thanks to recent productivity gains, Mexico has ever-more goods to export and is playing an increasingly important role in global manufacturing. In recent years, Mexican labor costs have become very competitive. In fact, by some measures, Mexican labor costs are cheaper than Chinese (see Exhibit 1), and many firms have re-sourced manufacturing from China to Mexico. Several automakers even use Mexico as an export hub to China! As a result, Mexico’s industrial output is climbing, and Mexican exports are witnessing their steepest growth in two decades (see Exhibit 2).
Exhibit 1: Mexican and Chinese Annual Manufacturing Wages
(Click to Enlarge)
Source: Thomson Reuters; as of 10/8/2012.
Exhibit 2: Total Mexican Exports (Annual, Seasonally Adjusted)
(Click to Enlarge)
Sources: OECD, US Federal Reserve; as of 10/11/2012.
While Mexico’s made strides on the global competitiveness front, there’s still ample room for further gains. Until the mid-1980s, Mexico’s economy was largely closed. Under the import-substitution industrialization (ISI) development model, trade barriers were high, and the state tried to control the economy’s development and trajectory through heavy direct investment. The ISI model’s shortcomings became apparent in the early 1980s, when President Miguel de la Madrid took office facing massive fiscal imbalances and stagnating economic growth. The need for significant foreign capital flows to provide an economic lifeline was clear, and de la Madrid set about opening Mexico’s economy. Tariffs were dropped, global trade ties were established, foreign investment was courted, and huge swaths of state-owned industry were privatized.
Since NAFTA’s adoption in 1994, however, reform progress has largely stalled. Even after the 1980s privatizations, Mexico’s economy remains dominated by a handful of large monopolies with strong state ties, and the resulting corruption has prevented further deregulation. Meanwhile, an abundance of red tape has driven a huge share of Mexican economic activity underground, robbing government of an important source of tax revenue. Nearly 29% of Mexican workers are trapped in this informal economy, where they’re largely unprotected. Simplifying the tax code, reducing regulations and freeing labor markets would be a boon to Mexican workers, businesses and state coffers alike.
And in July, Mexicans elected a president who sees this huge opportunity for economic reform. Enrique Peña Nieto of the Institutional Revolutionary Party (PRI) won the election with 38% of the vote (Mexico has a multi-party system where the victor need only win a plurality of the popular vote), over 6 points ahead of the runner up. Peña Nieto campaigned on a number of market-friendly proposals, including making labor markets more flexible, simplifying the tax code and increasing private investment in the state-controlled energy sector. Though he may not push for full monopoly reform given the PRI’s historically strong ties with Mexico’s large firms, Peña Nieto has signaled a desire to break with his party’s past, and even these more modest reforms would likely give the private sector a nice boost.
Since PRI doesn’t have a majority in either chamber of Mexico’s legislature, passing pro-market reforms won’t be easy, but the National Action Party (PAN) generally supports market-oriented reform, and together the parties will claim 90 of the upper-house Senate’s 128 seats and 321 of the lower-house Chamber of Deputies’ 500 seats. Their potential alliance passed an early test late last month, when a significant labor reform package succeeded in the lower house. The bill gives firms more freedom to hire and fire, creates new temporary employment options, promotes greater wage flexibility, streamlines the process for resolving employment disputes and, for the first time, legitimizes outsourcing. Though several provisions were watered down during the Congressional debates, and it must still clear the upper house (where it’s widely expected to pass, given PRI and PAN’s combined majority), once enacted it should foster significant productivity gains. Firms will be able to manage payrolls as they see fit, helping streamline costs, and greater flexibility should promote increased hiring—perhaps bringing some of the roughly 14 million informal workers into legitimate employment.
These reforms are but one example of the improvements Mexico’s new leadership could pursue—improvements that would help Mexico further boost its competitiveness. Opportunities exist internationally as well, as Mexico recently joined the Trans-Pacific Partnership trade talks. In our view, the strong potential for leaders to capitalize on these opportunities, combined with Mexico’s industrial strength and beneficial trade relationship with the US, should continue providing plenty of tailwinds for Mexican stocks.
This article constitutes the views, opinions, analyses and commentary of the author as of October 2012 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.