Mexico: trade, politics and profit

It was while posing for a selfie after a campaign debate last week that Fernando Puron became the lastest statistic in Mexico's wave of political violence. As a well-wisher approached Puron for a photo, another man loomed from behind and shot the presidential candidate in the head. The incident - captured on CCTV - is a stark reminder of the deadly risks of running for office in the central American country. 

On Friday, risk analysis company Etellekt will release its Fifth Report on Political Violence in Mexico 2018. It is expected to reveal the tally of politicians shot since the presidential race kicked off in September now runs to 112 people. It is the bloodiest general election campaign in recent history, and highlights the dangers of democracy in a developing economy.

Speaking before the Puron tragedy, Brian Giuliano, fixed income portfolio manager for Brandywine Global outlined some of the challenges facing the nation. Speaking with his colleague, Brandywine research analyst Alberto Boquin, Giuliano listed: "disappointing economic growth, increasing violence on the streets, Trump and the wall, NAFTA negotiations, and now we're a few weeks away from presidential elections and a populist candidate known for his strong rhetoric has a commanding lead in the polls."

Andres Manual Lopez Obrador – known as AMLO – continues to increase his polling numbers, currently polling with more than 50 per cent of the vote. AMLO's party Morena, the National Regeneration Party, also is leading in voting intentions and could win a majority in the Senate. This is the third time ALMO has run for president and, much like the anti-establishment figure of Donald Trump, now that his presidency is looking more secure his rhetoric has softened, making it difficult to predict the sort of leader he may be.

"AMLO is this sort of classic left of centre populist anti-establishment candidate. He is something that the political mood in Mexico is asking for at the moment," explained Boquin.

"There's generally a fear that he will roll back the structural reforms that Mexico really needed and he has spoken out against a few of them most vocally against the energy reform.

"He has made critical comments of the central bank in the past. And even though he has moderated his rhetoric this time around people still remember the AMLO of old. So, it's sort of hard to predict who he is going to be going forward.”

Economic outlook back on track

Economic fundamentals are not great, but they are not bad either. Last December inflation shot up to 6.77 per cent, but it is now a much more manageable 4.51 per cent. As a result, central banks raised interest rates, but the country is now back on track to hit inflation targets. Economic growth for the first three months of the year was meek at 1.1 per cent, with year on year growth of 1.3 per cent, the weakest since 2013. However, bond yields remain high, with the 10 year at 7.96 per cent - good news for income seekers, but generally yields that high come with a sustainability warning.

Domestic politics aside, Trump's plans to renegotiate the NAFTA – a trade deal between Canada, the US and Mexico – will have a big impact on the economic outlook as 30 per cent of the Mexican GDP today is manufacturing exports, most of which are going to the US. Such were the fears regarding Trump's plans, in the two months following Trump's election in November 2016, the Mexican peso lost 15 per cent of its value.

The latest thinking is that the US would do away with the current trilateral negotiations between the three countries be replaced by bilateral negotiations between the US and each of its partners.

The messages from the White House are mixed – while Trump has threatened to tear up the NAFTA agreement entirely several times, White House economic adviser Larry Kudlow recently insisted this was not the case. The US has also recently implemented tariffs on steel and aluminium trade with Canada and Mexico.

But Boquin is unconcerned.

"One stat that's good to remember is only about half of exports actually go under NAFTA tariffs and even if you were to draw from NAFTA you would revert to a World Trade Organisation tariffs which are not that much higher," he said. "So, it would definitely be a shock to the market. But Mexico would be able to survive."

Opportunities despite the challenges

Investing in Mexican stocks is not the same as investing in Mexico's economy, however. A look under the hood of the top Latin America equity funds reveals a sizable allocation to Mexican companies in most portfolios.

Top stocks include beverage firm Fomento Economico Mexicano, which rallied 25 per cent in 2017 alone.

Morningstar analyst Sonia Vora says the firm benefits from brand intangible assets and cost advantages stemming from its vast scale, both of which have allowed the firm to generate steady economic profits, with adjusted returns on invested capital averaging above 12 per cent over the last decade.

"We contend that the firm has been able to create synergies between its subsidiary Cola-Cola Femsa, which contributes nearly half of revenue, and its commercial arm, which includes the Oxxo chain of convenience stores, as well as several pharmacies and fuel service stations, as these retail locations can prioritise selling Coca-Cola Femsa's beverages while also leveraging these products' brand strength to drive store traffic," she explained.

Another top pick for fund managers is financial services firm Grupo Financiero Banorte, whose stock is up 53 per cent over the past five years, and the Mexican subsidiary of American consumer brands firm Kimberly-Clark, which has struggled in recent years, but over the long-term has delivered for shareholders.

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Emma Wall is senior international editor for Morningstar.

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