Conclusion: We are inclined to short Mexican equities on rallies in our Virtual Portfolio due to the combination of slowing domestic growth and slowing growth in its key export market (US). Fairly robust growth expectations need to be reset lower on all fronts.
Position: Bearish on Mexican Equities for the intermediate-term TREND.
Up until recently, Mexico has been boring to cover. With an economic cycle that closely tracks the US’s (lagging by about 1Q on average), there really hasn’t been much to talk about since our mid-February update. While not always the case, getting US growth story right will typically lead you to the promised land on Mexico (80% of Mexican exports go to the US in the form of automobiles, appliances, and, of course, crude oil). In fact, over the last 27 months, Mexico’s benchmark IPC Index has traded with a positive correlation of r² = 0.92 to the XLY and a positive correlation of r² = 0.91 to the XLP on a weekly closing price basis.
Needless to say, as the US consumer goes, so goes Mexico. And given that we authored the call on US Growth Slowing, as well as the Consumption Cannonball thesis, it would make sense for us to have a bearish bias on Mexican stocks – which we do, of course.
While the aforementioned factors are certainly supportive of being short/underweight Mexican equities, there is more to the thesis. As we pointed out in a report yesterday afternoon titled, “Hong Kong is Not Mainland China”, investors can indeed find themselves caught off guard as a result of playing surrogate investments based on trailing correlation studies. So in the essence of managing risk, we’ll quickly dive into the additional reasons that we are bearish on Mexican equities over the intermediate-term TREND.
Growth is Slowing; Expectations Need to Come Down
With the IPC Index down -8.2% YTD and broken from a TRADE & TREND perspective in our quantitative models alongside Mexico’s sovereign bond yields 10Y-2Y spread falling -45bps since peaking in Feb, PRICE is definitively telling us that growth is slowing south of the border. While not at all news to our Hedgeyes, we think many investors and policy makers alike will be surprised to the downside in coming quarters:
- Earlier this month, Mexico’s Central Bank raised its 2011 GDP forecast to +4-5% YoY from a previous range of +3.8-4.8% YoY, citing domestic consumption and private investment as reasons for the increase;
- Last month, Mexico’s Finance Ministry increased its 2011 GDP forecast to +4.3% YoY from a previous forecast of +4% YoY, citing a “strong US growth” leading a rebound in Mexican exports;
- Last month, the IMF raised its 2011 Mexican GDP forecast to +4.6% YoY from a previous forecast of +4.2% YoY; and
- In the last three weeks alone, the Bloomberg Consensus forecast for Mexico’s 2011 GDP has shot up from +4% YoY to +4.4%.
It seems everyone is bullish on Mexican growth except us… and the data, of course:
- Industrial Production growth slowed in March to +4.2% YoY vs. a prior reading of +5.2%;
- IMEF Manufacturing Index fell in April to 53.1 vs. a prior reading of 54.1;
- IMEF New Manufacturing Orders Index fell in April to 55.4 vs. a prior reading of 59.1;
- Export growth slowed in April to +12.6% YoY vs. a prior reading of +20.1%;
- Import growth slowed in April to +9.8% YoY vs. a prior reading of +16.3%;
- Trade Balance growth slowed in April to +$665M YoY vs. +$1.1B;
- INEGI Consumer Confidence Index ticked down to 89.7 in April vs. a prior reading of 91.7; and
- INEGI Retail Sales growth slowed in Mar to +1% YoY vs. a prior reading of +2.7%.
On the “glass half full” side of things, Mexico’s current +3.4% YoY CPI reading is running a near five-year low and Mexico’s Unemployment Rate ticked down to a 27-month low of 4.6% in March. In our opinion, the US rolling over from a top-down perceptive calls into question the sustainability of further improvement in Mexican employment statistics (which are a lagging indicator anyway). Our models don’t produce an overly malignant output for Mexican CPI, but we do think the probability of it bouncing off multi-year lows and surprising our “high” scenario is a risk to consider, given that Mexico’s benchmark policy rate has remained at an all-time low of 4.5% for the last two-plus years.
All told, we are inclined to short Mexican equities on rallies in our Virtual Portfolio due to the combination of slowing domestic growth and slowing growth in its key export market (US). Fairly robust growth expectations need to be reset lower on all fronts.