Oh, Mexico

Oh, Mexico, I’ve never really been but I’d sure like to go
Sing, whoa, Mexico, I guess I’ll have to go now

–James Taylor, “Mexico”

The presidential election is just about six months from now, but so far in 2024, investors have largely ignored politics. I suspect that will gradually begin to change in June with the presidential debate, and as the two candidates come more into investor focus, we can expect lengthy discussions of the policy implications for markets. Most of the policies between the two candidates are starkly different. But one area they are in agreement on is being tough on trade with China.

In this morning’s issue of the Eagle Eye Opener, my “secret market insider” and I explored the issue of China policy and how that may have filtered down to concerns about the emerging markets more broadly. And as you are about to read, there is one emerging market that usually flies under the radar that’s in good standing in trade terms with the United States, and that has outperformed and could be the beneficiary of U.S. companies diversifying away from China and other Asian countries.

That beneficiary is Mexico.

When most investors think of emerging markets, countries such as China, Taiwan, India and Korea are top of mind. That makes sense, as these countries account for over 70% of emerging market indices. But Mexico is just 2.7% in the MSCI EM Index, and we think it stands to benefit from the ongoing trends of “friendshoring” and “nearshoring.”

Friendshoring is a deliberate policy decision to encourage trade with friendly neighbors at a time when geopolitical tensions are high. The U.S.-Mexico economic partnership has strengthened due to Covid-19 and the United States-Mexico-Canada Agreement (USMCA, formerly NAFTA), which offers mostly duty-free trade zones.

Nearshoring is the practice of outsourcing a service to a third-party provider in a nearby country. This is obvious with Mexico’s close proximity to the United States and a nearly 2,000-mile U.S.-Mexico border. Goods from Mexico can often reach their U.S. destinations in a day or two by truck or rail. (Additionally, Mexico has sea access to Asian and European export markets via the Pacific Ocean and Gulf of Mexico, providing another way for foreign goods to get to the United States. And Mexico has free trade agreements with roughly 50 other countries).

In fact, Mexico became the No. 1 trade partner of the United States in 2023. It took the spot from China, which was the leader for about a decade. Mexico offers numerous advantages that should allow the continued diversification of global supply chains by multinational companies (nicknamed “China plus one”) to make a sustained impact in the years ahead.

Advantages include a skilled and young labor force, cheaper labor, government incentives (discounts, grants, training, tax incentives, etc.), solid infrastructure in the north and easy access to the United States (beneficial to foreign countries, too). Some manufacturers estimate up to 25% production cost savings in Mexico versus equivalent U.S. facilities, and hundreds of U.S. companies are taking advantage.

Here’s a sampling of large U.S. companies with headquarters, R&D, operations, outsourcing and/or investments in Mexico: Ford, Procter & Gamble, American Express, GM, Microsoft, John Deere, Amazon, FedEx, AT&T, Meta Platforms, Coca-Cola, McDonald’s, Walmart, Pfizer, IBM, Exxon Mobil, General Mills and Nike. Notice the diversification, with companies from many sectors and industries.

As Bradford Freer, portfolio manager of the New World Fund, said regarding a recent visit to Mexico, “I was shocked to see the magnitude of what’s happening. It reminded me of the cities I visited in China during the 1990s and early 2000s, with these bustling multi-million square foot facilities and thousands of workers building at scale. That’s now happening in northern Mexico at a rate I think is surprising to a lot of people.”

Beyond the friendshoring and nearshoring catalysts, Mexico has other solid growth and value characteristics in play. The country has momentum, as the MSCI Mexico Index was up 41.5% in 2023, strongly outperforming the S&P 500 Index’s 26.3%. (Mexico also outperformed 19 of the other 23 emerging market countries last year.) The iShares MSCI Mexico ETF (EWW) has a 2.4% dividend yield, which is double SPY’s 1.2%. And it’s considerably cheaper in terms of price-to-earnings (P/E) ratio, 11.4 (EWW) versus 22 (SPY).

That’s not to say there aren’t risks, which include: 1) Mexico’s electricity grid needs to be strengthened, 2) Southern Mexico is underdeveloped compared to northern Mexico, 3) Corruption, 4) Presidential elections are coming for both Mexico (early June) and the United States (early November) in 2024 and 5) U.S. recession (the biggest risk).

For investors, there are three good Mexico exchange-traded funds (ETFs) to choose from: iShares MSCI Mexico ETF (EWW), Franklin FTSE Mexico ETF (FLMX) and Direxion Daily MSCI Mexico Bull 3X Shares ETF (MEXX). EWW is likely the best option if you’re inclined to make a direct bet. It has the highest assets under management (AUM) ($2.1 billion), most liquidity (trades two million shares per day) and longest history (1996 inception).

FLMX is the least costly option (0.19% expense ratio). And MEXX, although very risky with its leverage, provides the most bang for your buck. EWW also has a 0% weight in the technology sector. So, if you’re overweight technology, it can serve as an offset.

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The Pleasure Principle

“What we learn with pleasure we never forget.”

–Alfred Mercier

For a rational man, pleasure is a result of the achievement of values. It’s the result of confirmation in your mind’s ability to grasp, unpack and mold reality. I find that learning is one of the most pleasurable pursuits I can engage in. Yes, learning new skills can be strenuous and frustrating at times. Yet when that strain and frustration results in the discovery of something new or a newly acquired skill, well, there can be no pleasure greater than that.

Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.

In the name of the best within us,

Jim Woods