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Mexico, not Brazil, is a winner market

(MACRO IDEAS)
Filed on June 4, 2012

Latin american stock markets have lost 25 per cent in dollar terms since early March, primarily due to a global run on the Brazilian real and Sao Paulo’s Bovespa index.

Brazil’s fall from grace for offshore fund managers owes itself as much to the post-Lula economic disillusionment and subsequent rise in sovereign risk as to the bloodbath in global commodities, a slowdown in China and fears of a Greek default/contagion in EM. While the Bovespa, technically in a bear market, trades below 9 times forward earnings, EPS estimates can still fall lower this summer.

In any case, the Bovespa bottomed at seven times forward earnings after Lehman and the 2011 late summer global sell off. Yet the dramatic fall in the Brazilian real creates an opportunity to at least nibble at Vale, the Brazil mining colossus, whose revenues are almost all in dollars while most costs are domestic. An obvious short is Petrobras, which suffers both from the $20 fall in Brent crude and whose balance sheet is largely leveraged with dollar debt.

Brazil’s periodic mood swings are notorious (at least a dozen 30 per cent corrections since President Cardoso and my old Wharton thesis advisor Arminio Fraga-Neto launched the Real Plan in the late 1990s). I do not believe it makes sense to bottom fish in the Bovespa until we trade down to 48,000, China stabilises, the global scramble for the dollar ends, the Greek election passes and domestic GDP growth data improves. The land of samba, Roberto Carlos, Gisele, Caipirinha and Ipanema Beach is not.

I believe Mexico is far more resilient to global angst than brazil, since Nafta led to a manufacturing export sector tied to US industrial growth and much lower tariffs, despite Pemex’s mediocre/even falling oil production in the Gulf of Compeche. The EPS consensus in Mexico is 24 per cent, double the rate in Brazil. Naturally, the financial markets have priced in comparatively a huge premium in the Mexico City Borsa’s IPC index, that now trades at a huge valuation premium to the Bovespa at 15 times earnings. Mexico bottomed at nine times earnings four months after Lehman’s failure so it is not immune to a savage valuation derating if a Greek exit escalates to an ice age in credit/debt markets, a banking credit crunch and, horror of horrors, even global recession.

Mexico’s IPC also trades at three times book value. Moreover, I believe that the Mexican peso will eventually rise to 12 against the dollar, even though EM FX risk aversion can easily take us down to 14.50 before the Hellenic sturm und drang ends. Mexican public sector debt is a mere third of GDP even as Uncle Sam’s trillion dollar budget deficit. Banco de Mexico is one of the Latin America’s most independent central bank, no longer the plaything of the Hacienda, the Finance Ministry since Ernesto Zedillo succeeded the disgraced Carlos Salema as President after the tesobonos scandal, peso devaluation and Chiapas revolt of December 1994.

The Mexican peso had actually strengthened by nine per cent against the dollar until the latest risk aversion. Mexico offers a far more attractive growth/inflation/policy/FX to me then either Brazil or the Peronist Argentina (beyond the pale for FII after the Repsol YPF nationalisation). Mexico’s CDS make it a more attractive sovereign credit risk than France, the budget deficit is a mere 2.5 per cent and the current account deficit is less than 0.8 per cent GDP ($9 billion against India’s shocking $180 billion and Turkey’s $80 billion). Mexico is a long-term EM winner, as long as President Calderon’s successor continues a merciless war against the narco-trafficante drug cartels. The Mexican peso is a currency I can finally believe in, but only at 14.5 against the dollar.





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