Although it may seem like Andrés Manuel López Obrador (AMLO) took office a long time ago, his presidency has barely crossed the 100-day mark. In this piece we present the key takeaways of his presidency so far and focus on what to expect for the rest of the year.
By now Mexico watchers have had the opportunity to digest the drastic change in policy path Mexico has experienced since AMLO‘s electoral victory last July. Quite interestingly, a large gap in perception has developed between investors and the local population regarding the outlook for the country. While the former remain by-and-large cautious, the lion's share of the locals envision a more promising scenario.
To gauge the optimism of the Mexican voter, one should look no further than to consumer confidence and presidential approval ratings, both of which stand at historical highs (see Fig. 1). We note, however, that this positivity hasn't so far translated into spending, as reflected by so-far uninspiring company earnings results. We are actually projecting a relatively poor 1Q GDP reading on the back of a variety of factors, including a prolonged period of fuel shortages, the blockage of freight railroads, and labor strikes in the state of Tamaulipas.
Figure 1 - Consumer confidence at record high
Consumer confidence index
Investors are far less impressed. Over the last few months, members of AMLO's coalition introduced several controversial proposals to Congress that shook up the markets. The recommendations included imposing new rules in the mining sector and modifying Article 35 of the Constitution to grant more freedom to hold referendums. Crucially, increased concerns about Pemex‘s financial health on the back of poor energy sector policies have led to negative credit rating pressure on Mexico. It is highly likely that the government will be forced to take additional measures to rescue Pemex, which would undermine fiscal policy credibility. The recent announcement that the government will draw USD 7bn from the country's rainy-day fund to support the company constitutes a one-off move and fails to address the key structural issue, i.e., the poor overall strategic direction of the energy sector. Pemex's oil output has undergone a 14-year decline, and underinvestment in exploration and production will translate into further deterioration.
Overall, we think the softening investor sentiment is justified and envision a gradual but steady worsening of macro policies, accompanied by a more challenging micro and regulatory environment, all of which will over time weigh on the country‘s growth and inflation outlook. Potential negative headlines around the US–Mexico–Canada Agreement (USMCA) ratification cannot be ruled out either as the US presidential race picks up speed.
We therefore remain cautious on Mexican assets. We recommend buying the Brazilian real against the Mexican peso as political dynamics point to a divergence in their respective performance, and expect economic momentum to favor the real later in the year.
Although we are neutral on Mexican equities, we see downside risk to the high-double-digit consensus earnings growth expectation. We prefer stocks with non-Mexican exposure and dollarized revenues. We also favor yieldpaying companies (industrial FIBRAs) and consumer companies.
Finally, we are cautious on Mexican sovereign credit but continue to see opportunities in Mexican corporate bonds with a large share of foreign revenues.
The main risk to our cautious view call is a “risk on” episode, which would strengthen the peso and increase investor appetite for cheap Mexican equities. Another risk is AMLO being more pragmatic and fiscally responsible than we anticipate.
Gabriela Soni, Emerging Markets Strategist Mexico, UBS Financial Services Inc. (UBS FS)
Alejo Czerwonko, Emerging Markets Strategist Americas, UBS Financial Services Inc. (UBS FS)