By Portfolio Manager, Randall Coleman
The biggest trade relationship between two countries in the world belongs to the United States and its northern neighbor, Canada. Our country’s second biggest trading partner is, not surprisingly, our southern neighbor, Mexico. Public perception of Mexico garners, not completely without merit, substantial negative attention. The U.S. Department of State has Do Not Travel warnings for 6 Mexican states and Reconsider Travel warnings for an additional 7 states, citing crime and kidnapping as the primary risk factors. Drug cartels, violent crime, corruption, illegal migration into the U.S., economic mismanagement—you name it, the country sounds like a bad place to do business. If your analysis stops there, you would miss out on one of the more dynamic opportunities available to U.S. investors. With all the “bad stuff” going on, why should ACM’s global investment strategies have exposure to Mexico at all?
Geography, longevity, and proximity are essential ingredients underlying the case for investment in Mexico. By “geography,” we don’t simply mean “our neighbor to the south.” Global trade blocs have been shifting from historical norms for many years. Where east-west flows—Europe-to-North America or Asia-to-North America, for example—used to dominate, these blocs have been shifting to a more north-south, region-centric paradigm. The U.S., Canada and Mexico obviously fit into this category. The USMCA (United State-Mexico-Canada Agreement), which went into effect in July 2020, updated and replaced the previous NAFTA (North American Free Trade Agreement) regime which had been in place since 1992. The USMCA is seen as highly positive for Mexico as more than 83% of its exports go to the United States. Trade flows are not one-way. Mexico is the U.S.’s second largest export market. According to the Department of Commerce, U.S. exports of goods and services to Mexico supported an estimated 1.1 million U.S. jobs in 2019. In 2021, Mexico was the top destination for U.S. petroleum product exports and U.S. natural gas. Besides energy, U.S. exports to Mexico include machinery, electrical machinery, vehicles, and plastics. The north-south geographic link is strong and growing.
Longevity speaks to the deep and symbiotic relationship between the two countries. Mexico and the U.S. celebrated 200 years of diplomatic relations in December, 2022. Company, industry and government-sponsored research ties go back decades. One example is the 1972 Agreement on Scientific and Technical Cooperation which has contributed to collaborative research on health, meteorology, hydrology, earth sciences and energy. While relations between the two countries have not always been amicable, the partners have always found mutually agreeable and beneficial paths out of disagreements. We see no reason for this dynamic to change.
While geography and longevity lend a solid base to the investment climate in Mexico, it is proximity that forms the bedrock of the near-term investment case. By virtue of being close, Mexico stands to benefit extraordinarily well from the wave of “nearshoring” going on in international trade. The Covid pandemic gummed up the global supply chain to a near standstill. To gain heightened control of their production capacity, companies around the world have opted to source inputs for their products closer to home. This is the gist of nearshoring. The north-south nature of our ties with Mexico creates an added benefit since similar time zones help businesses immensely, particularly in the easing of communication and coordination.
Trends in FDI (Foreign Direct Investment) highlight the flow and magnitude of investment into Mexico. Not surprisingly, manufacturing and transport & logistics are a primary recipient, although new investment touches all areas of the economy (see graph below).
The magnitude of the opportunity is large, estimated at $35 billion, with Mexico being far and away the biggest winner in the region. According to the estimates in the graph below, Brazil’s number two potential gain is less than a quarter of Mexico’s. Proximity wins hands down.
With nearshoring as the driving force, we expect outpaced growth from Mexico.
As we have pointed out before, U.S. equity outperformance doesn’t last forever and U.S. dollar strength does not last forever. Both have periods of underperformance. Recent performance in both indicators may signal a longer term trend. The Bolsa (MEXBOL), Mexico’s biggest stock index, is off to a strong start in 2023:
A long stretch of underperformance was broken in 2022. The MEXBOL index beat the S&P 500 by more than 12% last year, or better than 17% with the currency tailwind from peso appreciation (see chart).
The pillars of growth for the Mexican market will not impact companies uniformly. The importance of analyzing corporate governance and incentive structures to ensure alignment between majority and minority shareholders and management is critical and is a hallmark of ACM’s approach to company selection. Dividends play an important role in our investment decision, characterized by the “trust but verify” dictum. Dividends are the true test of verification.
Finding investments in Mexico meeting these criteria can be challenging but we have identified and invested in a couple promising Mexican companies in our ADR, Global, Balanced, Growth, and Income with Growth portfolios. We believe these companies will benefit from the improving business climate engendered by increased U.S. near-shoring.
The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.