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How to position portfolios for a new Mexican regime

Jorge Amato

By Jorge Amato

Head - Latin America Investment Strategy

July 5, 2018

The Mexican presidential election preliminary results show Manuel Andres Lopez Obrador (AMLO) poised to deliver a crushing defeat to runner up Ricardo Anaya with 53.4% of counted votes versus 22.6% – 3rd place Jose Antonio Meade has 15.8% (Reuters).  Votes are still being counted but Anaya and Meade have already conceded.

AMLO’s Morena party also had strong results at the state level, winning 5 of the 9 gubernatorial positions. The current count also reveals a majority in both houses in Congress with 51-53% in the Lower House and 57% in the Senate. A supermajority (2/3 majority in both chambers) required to make constitutional changes such as modifications to energy reforms or independence of the central bank is highly unlikely to materialize.

These results show a wider victory than polls had been suggesting and mark the beginning of a strong mandate for the new administration.

AMLO will assume the presidency in December. New congress members take their place in September and will vote on the 2019 budget before year end. Thus a new political cycle, outside the grasp of the old PRI/PAN/PRD establishment, has begun.

We expect short term upside for Mexican assets as AMLO’s early messaging was moderate and conciliatory. However, and despite attractive valuations, we maintain a more cautious neutral for longer term global diversified portfolios as policy uncertainty remains elevated along with risks of shifts in economic policy.

As we have discussed previously, an AMLO presidency that fulfills his campaign promises is likely to generate medium term deterioration in macroeconomic fundamentals, particularly on the fiscal side. The economy continues for the moment in its cyclical post crisis recovery.

Anecdotal evidence from our visits to Mexico suggests that while domestic investors have rightly taken a cautious approach to the elections and have hedged their local asset exposure, they have not abandoned the idea of continuing to invest in the local economy.

Future investor behavior will depend on what AMLO continues to do and say. Short term market reaction will hang on his words.

Going forward we look for key sign-posts in:

  • Signaling over economic policy
  • Monetary – expected to maintain central bank independence
  • Fiscal – inconsistent with expected increases in spending but unclear ways to fund it
  • New airport project – AMLO could temporarily halt the project but his positions have shifted throughout the campaign
  • Energy reform – supermajority needed for major changes but AMLO can still have a negative impact in various ways
  • NAFTA – AMLO had suggested he would follow current path of negotiations
  • Relationship with the private sector – he has signaled no intent to nationalize private property
  • Degree and level of government intervention

How should investors position their portfolios?

Short-term opportunistic investors could run long risk-biased positions in equity, FX and bonds markets. Volatility likely to remain elevated but potential returns are attractive.

Medium term portfolios should maintain a neutral bias as we see policy risks and valuations as more balanced.

Investors with a large home bias should maintain a cautious medium term approach as economic policy risks have increased.

The daily thermometer for Mexican markets will be the currency. Other markets will price and trade of off how the MXN is behaving. Given pre-electoral hedging activity and ensuing MXN weakness (reaching almost 21.00), the technical position of the market seems short MXN vs the USD.

With the uncertainty of the election now over, we could see a continuation of the recent rally as shorts are covered. Again much will depend on what AMLO does, but expectations are building up that he might not be as bad for equity and fixed income markets as anticipated, at least not initially. We believe this also bodes well for the currency.

We believe equity, bond and currency valuations under the current macroeconomic framework (monetary and fiscal orthodoxy, open economy, free markets, independent central bank, non-interventionist administration) are very attractive. However, and given future domestic policy uncertainty and potential trade conflicts with the US, markets have applied large discounts to these valuations.

The answer to where medium term fair value lies for Mexican markets will remain an elusive one. We are more concerned about the direction of macro policy than about NAFTA related trade risks. However, we recognize that both are inexorably linked.

Outside the specific domestic political uncertainty, Mexican markets are likely to be influenced by overall global financial market gyrations, which as of late have been dominated by trade war fears.

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