Mexico flag
by David Ruff CFA, Global Portfolio Manager

Lost in the impeachment and coronavirus headlines the last couple weeks was the January 29th U.S. ratification signing of the United States-Mexico-Canada-Agreement, known as USMCA. Viewed as mildly positive for the U.S. but crucial for Mexico, the deal replaces the 26-year old North American Free Trade Agreement (NAFTA). Not yet ratified by Canada, but expected soon, this could not have come at a better time for our southern-border neighbor. While Mexico faces significant challenges, the deal should instill business confidence and provide the impetus to reverse flagging growth.

Mexico’s 2019 economic growth rate approached stall speed in the second half of the year. Weak vehicle demand both domestically and in the U.S. hurt Mexico’s all-important auto industry, a condition exacerbated by the General Motors U.S. workers’ strike. Government policy uncertainty under the new administration of President Andrés Manuel López Obrador (AMLO) lowered business confidence, stifling investment and hiring. Fading production by the state-owned oil company, Pemex, is another headwind. Less oil and gas revenues translate to persistent fiscal deficits limiting government spending. Adding to the gloominess, the construction industry appears to be in plunging mode with both government projects canceled and private building stymied. Only resilient consumer spending keeps the economy moving forward, albeit, in a limping fashion.

Of course, the weakening global economy negatively impacted Mexico, but much of their problem appears self-inflicted. AMLO’s delaying and canceling of several state-spending projects, particularly the October 2018 Mexico City airport expansion, sent a shockwave through the business community. Already rattled by President Trump’s threats of immigration-engendered punitive tariffs and a new, less beneficial trade deal for Mexico, the news effectively paralyzed long-term investment decision-making with executives fearing the return to a largely state-controlled economic system. Such fears are not unfounded. In addition to energy, AMLO is trying to exert greater state control over the power industry, which is also inefficient, and in dire need of private investment for cheaper, cleaner electricity production. Add in the inability of Mexican security forces to stem ongoing drug-cartel violence, highlighted by the record 28,649 homicides in 2019, representing a 7.5% increase over 2018, and you can make the case that Mexico is a market to avoid.

All is not lost, however, and the USMCA agreement has meaningfully changed business sentiment making the market much more attractive. True, the new deal is not quite as favorable for Mexican companies with new provisions stipulating more intellectual property protections for U.S. firms, and a higher average wage for Mexican vehicle manufacturing workers, but it also ensures greater manufacturing in Mexico by preventing outsourcing away from North America. Most importantly, decision makers know and understand the rules and can plan accordingly. On a recent visit to Mexico City and Monterrey I had the opportunity to meet with several analysts, strategists, and company executives. U.S. opinion of USMCA elicits a collective shrug with many noting it’s not meaningfully different from NAFTA, with some calling it NAFTA 2, but the universal expressed opinion about the new Agreement in Mexico is a huge collective sigh of relief with many expressing unbridled enthusiasm for Mexico’s future. One analyst quipped “we can finally get back to work”, which I think epitomizes the mood in the Mexican business community at moment.

Other positives for the country include an accommodative Central Bank. The Bank of Mexico’s lowering of interest rates supports credit growth and investment. Further, AMLO, has not shut off government spending, but redirected it, making better infrastructure a key campaign promise. Headlining his infrastructure effort includes an ambitious new 950-mile passenger and freight train project connecting several states in and near the Yucatan peninsula. The four-year, $8 billion project should support the construction industry, and boost the southern economy. AMLO seeks to strengthen education standards, and despite his populist reputation, is pursuing business-friendly tax reform. These efforts help Mexico’s global competitiveness, adding to the country’s multiple structural advantages, one of which includes the country’s access to the all-important U.S. market. Policy makers emphasize duty-free trade making the country an attractive destination for foreign factories. Having more trade agreements than any other country in the world, Mexico’s export success is advancing beyond tortillas, fruits, and vegetables. Indeed, in addition to being fourth largest exporter of vehicles, the country is becoming a major manufacturer and exporter of electronics, medical devices, aerospace parts, and machinery.

With such tailwinds, income per capita growth will continue and this is where we have focused our Mexico investments, favoring companies benefiting from rising consumption. During one recent meeting an executive segmented Mexico into three socioeconomic strata with the top tier comparable to Spain, the second commensurate with Turkey, and the bottom tier akin to the Democratic Republic of the Congo. While the top tiers have the greater spending power, competition is more intense making analysis crucial to determine the company’s ability to differentiate their products and services. Also, noting that 80% of the population falls into the bottom tier, and the fact that Mexico’s minimum wage hikes in 2019 and 2020 provide improved discretionary spend capability, we think this segment should not be ignored. Thus, we have focused on company investments profiting from all three tiers.                                                                                                                                                                                                                      

David Ruff ACM’s senior international portfolio manager (center) in Mexico City with executives from OMA or Grupo Aeroportuario del Centro Norte. OMA is the central Mexico airport operator.

During my visit to Mexico I enjoyed many spicy, hearty, and delicious foods. The meals seemed to give me a burst of energy compared to my typical fare. I look for the Mexican economy and especially the Mexican consumer to display a similar boost in economic energy in the coming years.


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