The glittering treasure you are hunting for day and night lies buried on the other side of that hill yonder.
The Treasure of the Sierra Madre
“There are definitely a lot of people trying to figure the [relative value] in a Trump world,” one Wall Street bond investor recently told me following the election of Donald Trump as US president. Relative value — the attractiveness of one financial instrument compared with another — is always the question for professional traders and dispassionate arbitrageurs.
Desperate pension and insurance managers, in contrast, along with the income-starved retired, have been overreaching for interest income in recent years. This leads them to buy high-yielding paper such as Mexican peso bonds, and to under-discount risks such as devaluation. They hold on to their losing positions for too long and then dump them at close to the worst moment.
B Traven, the Mexican writer, might not seem to be a natural investment adviser, but he had a point about proximity and fortune. The peso’s deep devaluation now makes Mexico a good bet for bond and currency people.
They would have to get past the idea that risk is best measured by volatility, because Mexico has had a lot of that lately, particularly after the election of Mr Trump. The peso has been devalued by -12 per cent since then, and -20 per cent since the beginning of the year. The Banco de Mexico has raised its policy rate by 50 basis points to 5.25 per cent, and the consensus is that they must raise it again soon.
The incoming Trump team has pledged to reinforce the US’s southern border and to take a hard line in renegotiating the North American Free Trade Agreement, a three-country accord between Canada, Mexico and the US, as well as other arrangements with Mexico.
The president of Mexico is remarkably unpopular, growth is slow and infrastructure projects such as a national broadband network and a renewal of the railways have been delayed. Mexico suffers from high costs imposed by oligopolies, corruption and bureaucratic inefficiency. Also, there are high casualties in a continuing conflict with, and among, the country’s narcotics gangs.
My view is that all this is already over-discounted by the currency and bond markets. This is the fourth time in my working life that everyone has decided Mexico is a macro disaster, and each time it has recovered.
The incoming administration will probably come to understand that there are, arguably, limits on portraying America as a victim of Mexico. The US trade deficit with Mexico is about 26 per cent of US exports to Mexico, compared with a US trade deficit with China of more than three times its exports, and a trade deficit with Japan of more than 100 per cent of exports.
Supply chains will probably become less global and more local, but Mexico will not be cut off from exporting to the US.
I have heard from people working on industrial projects with Mexico who describe the state of shock that Mr Trump’s election created among Mexican officials. They could respond, though, by extending already significant reforms in energy and telecoms policies to other sectors. Mexico could also do more to carry out infrastructure development, particularly in broadband and rail networks.
Mexico will have influential allies in the energy industry. With the reform of Pemex, the national oil company, US companies have become much more active in Mexico. Six new gas pipelines from the US to Mexico are being built now. Republicans vs oil and gas producers? Maybe not.
The incoming US administration’s lack of interest in multilateral trade deals with Europe and Asia could also work in Mexico’s interest, in a zero-sum sort of way. The EU and Mexico are currently negotiating a “global agreement” that is intended to lead to a trade and investment treaty comparable to the Comprehensive Economic and Trade Agreement, a free-trade deal between Canada and the EU. Mexico could prospectively be a more attractive platform for multinationals than the US.
So the political-economic outlook for Mexico is not as bleak as it seemed to some on the morning of November 9. The Mexican peso and bond market “technicals” (the flows of cash in and out of an asset or asset class), have been unfavourable lately, since yield-chasing investors had all been on one side of the trade. The consequent moves against the currency and Mexican bonds may not be over just yet, as there is probably one more increase in the policy rate, and some year-end selling.
Very shortly, fixed income and currency people will have to take notice of the cheap value on offer. Mexico’s short-term Cetes bills, foreign holdings of short-term paper and 10-year bonds now yield about 500bp over the comparable US Treasury issues and real returns over 4 per cent. The Mexican peso is about 35 per cent undervalued on a purchasing power parity basis.
B Traven’s “glittering treasure” is on the other side of the Rio Grande.