Is the Mexico ETF a Better Play on Latin America?

Latin America, dominated mostly by Brazil, seems to have lost luster since the taper talk was initiated in the U.S. last year. Apart from the external shocks, many nations in this corner of the world are lacking structural reforms and grappling with poor public finances as well as reduced foreign investment.

As per the Inter-American Development Bank estimates, economic growth in Latin America is estimated at 3% in taper-trodden 2014 and 3.3% in 2015. Investors should note that this is the best case scenario. Any anticipated acceleration in QE wrap-up in the U.S. and prolonged deceleration in China might disrupt this growth pace.

These concerns make it necessary to look for some solid options in the Latin American space. Gone are the days when Brazil was the only bright spot in South America. In fact, Latin America’s second largest economy, Mexico, at present offers more potential than the space-bellwether (read: 7 ETFs to Buy in 2014).

Though Mexican stock exchanges was down about 14% last year and also suffered the most in the Latin American space to start this year, the market rebounded in late March. Significant reforms introduced by the Nieto administration presumably played a role in lifting the cloud over the nation.

Let’s dig a little dipper into the country and its current economic outlook:

Unemployment Rate on Decline: Lower-than-expected unemployment numbers in February provided a much-needed boost to the economy. The Mexican jobless rate fell to 4.65% in February from 5.05% in January. The rate was below analysts’ expectation.

This was in contrast to Brazil’s unemployment rate which rose for two successive months. Investors should note that the Mexican unemployment fell to a 5-year low level last December.

Analysts expect Mexico to create more jobs over time. Rising wages in China, higher transportation costs; the nearness of Mexican factories relative to the U.S., and the resultant reduction in delivery times might force many manufactures to prefer Mexico to China as an off-shoring base.

Inflation at Check: Unlike Latin America’s largest economy, Brazil, the best part of Mexico is contained inflation which is helping the latter to follow an interest rate policy needed to spur the so-far-wallowing growth rate. Annual inflation slackened to 3.94% in the first half of March, lower than the 4% upper limit of the central bank’s objective.

A softening in inflation points to no need for policy tightening, instead gives room for policy easing in case the growth scenario worsens. Mexico slashes its rates thrice last year to boost economic growth. Notably, in its latest meeting, Mexico maintained its rate at 3.5%. Economists surveyed by Bloomberg anticipate Mexico to maintain rates until second quarter next year.

Recovery in largest export market: Mexico – an export oriented economy – is a huge beneficiary of U.S. economic revival, probably more than many other countries in the world. This was because the United States is Mexico’s largest trading partner with the latter exporting more than 75% of commodities to the former.

As much as 60% of Mexico’s agricultural exports reach the U.S. every year. Hence, the U.S. economic recovery is indirectly giving reasons to be bullish on Mexican GDP view (read: Emerging Market ETFs: Any Bright Spots?).

Improving Growth Outlook: The Mexican economy slowed to a growth rate of 1.1% in 2013 from 3.9% growth recoded in 2012 hurt mainly by the taper talks in the U.S. However, the economy is expected to resume 3% growth this year on rebounding internal and external fundamentals (as per IMF). Short-term factors that weighed on the Mexican economy last year appear to fade. As per OECD, Mexico should clock 4% growth in 2015.

Opening the doors to foreign investors in the state-controlled energy sector is another positive for the nation. The government believes that opening up in the oil industry will boost growth by 1 percentage point by 2018.

On the contrary, as per IMF, average growth in other South American nations like Brazil, Chile, Colombia, Peru will likely remain less than 4% which is low by historical standards. In fact, all these nations are highly trade-dependent on China, a nation that is buckling under heavy economic pressures.

Also, weaker commodity prices and somewhat tighter financial conditions in nations like Brazil (that went through a series of rate hikes in the recent times) will likely keep many Latin American nations including the ones mentioned above under pressure. IMF now expects Brazil’s growth to be 2.3% this year, lower than Mexico’s projected growth mark.

Low Debt-to-GDP Ratio: As per OECD, Mexico’s macroeconomic position remains in good shape, with a modest debt level (below 50% of GDP) and a low temporary deficit of 1.5% of GDP.

Standard & Poor’s has a decent credit rating of BBB+ on Mexico. Another agency, Moody’s, raised its rating by a notch to A3 in early February thanks to the opening up of the Mexican energy industry to foreign investors.

On the other hand, Brazil’s debt-to-GDP ratio remains more than 60%. As far as credit rating is concerned, Standard & Poor’s slashed Brazil’s credit rating on March 24, to BBB-, the agency’s lowest investment-grade rating, from BBB.

Market Impact

Over the medium term, Mexico looks more resilient than any other Latin American nation. Although Brazil has managed to secure some gains in recent trading as some election talk is helping to boost this market, its long-term picture still looks gloomy.

Also, with Ibope, Brazil’s top polling firm, predicting another win for the current president Rousseff, sparks are not flying in the Latin America’s biggest nation (read: Will the Recent Surge in Brazilian ETFs Continue?).

Moreover, other better-growing Latin American nations like Chile and Peru thrive on metal exports which make them vulnerable to Chinese manufacturing slowdown. On the other hand, Mexico exports mainly agricultural products and thus it is far more prone to Chinese deceleration.

Thus, investors willing to seize the potential in South America’s second biggest economy might consider the following ETF for exposure.

iShares MSCI Mexico Investable Market Index (EWW)

EWW tracks the MSCI Mexico Investable Market index which consists of stocks traded primarily on the Mexican Stock Exchange. The index is a capitalization weighted index that aims to capture 99% of the total market capitalization (See more in the Zacks ETF Center).

Making its debut in March 1996, the fund now has more than $2.5 billion in AUM. The assets are invested in 51 holdings. Consumer staples (21.9%), financials (20.06%) and materials (16.5%) are the top three sectors of the portfolio.

However, the ETF bears high concentration risk with America Movil SAB alone accounting for about 16%. More than 60% of the portfolio is invested in the top-10 holdings (read: Two Country ETFs to Buy on Metal Strength).
The fund charges 48 basis points per year in expenses and currently has a 30-Day SEC yield of 1.21%.

The ETF has gone up about 4.50% in the last one month. EWW currently holds a Zacks ETF Rank of #3 (Hold), and it may be an interesting bet for investors in the Latin America ETF market.

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