Market Memo: Add some salsa to your international portfolio
When it comes to seasoning your international portfolio, may we suggest a little salsa? Mexico has emerged as one of our favorite country picks, with Brazil trailing relatively close behind. Both offer a nice mix of strong economic growth and stable fiscal-debt environments indicative of many developing markets in the post-global-financial-crisis world.
Mexico’s particularly compelling at this juncture. We expect annual real GDP to expand by an above-trend 3% to 4% the next few years, abetted by a booming export sector that is much more reliant on the United States than on the struggling eurozone and the downshifting Chinese economies. Roughly 80% of Mexican exports end up in U.S. factories and households, with a major thrust in the U.S. automotive market fully awakened from a prolonged slumber. Mexican auto production has jumped from 1.5 million units in 2009 to 2.5 million last year, and is expected to grow by 13% to 15% this year.
Given its competitive wages, attractive location to the world’s largest market, an open and free economy with no capital controls, and a free-floating exchange rate, NAFTA-member Mexico also is experiencing a flood of foreign investment, both from U.S. companies and European and Japanese manufacturers seeking to boost production efficiencies and take advantage of relatively low transport costs into the large U.S. and Canadian markets. Foreign direct investment is on pace to top $7 billion this year, exceeding the three previous years combined, with Audi, Nissan, Honda and Yokahama all having announced plans to build facilities and BMW potentially waiting in the wings.
Concerns about organized crime helped bring the long-ruling Institutional Revolutionary Party back in power with the summer’s elections after a dozen years in exile, but without a sweeping mandate that political observers had been expecting. As noted, Mexico’s economy also is still tightly tied to that of the United States, where growth continues to be subpar and uncertain—the old adage still applies, “If the U.S. sneezes, Mexico catches a cold.’’
Valuation-wise, Mexico’s equity market also appears pricey, trading at 16.5 times forward earnings. That’s roughly a 50% premium to the MSCI All Country World Index; historically, Mexico has traded at a discount. This suggests Mexico’s markets could underperform in a global rally. But we think strong earnings and top-line revenue growth, combined with high margins (19% ROE) and low funding costs, justify the current prices.
Brazil positioned to weather global slowdown
As for Brazil, we’re more encouraged by the longer-term prospects. Because it’s a lot more dependent on overseas growth, its domestic consumption is at risk while Europe struggles and China appears poised to pause. But unemployment remains near historic lows, its fiscal situation remains solid and inflation, though at the high end of targets, remains relatively subdued. This is allowing Brazilian authorities to be somewhat aggressive, adopting tax cuts to spur purchases of cars and home appliances and slashing a key lending rate by 500 basis points to record-low 7.5% over the past 12 months.
Net foreign direct investment also has remained strong and on par with the year-ago pace. Companies such as Lenovo, which invested $147 million in three Brazilian tech companies, are looking to expand their presence to gain a bigger share of what is the world’s fifth-largest PC market. On the energy front, foreign companies such as GE, Rolls Royce and Finland’s Waertsilae Oyj are acting to cash in on Brazil’s oil boom, as are many domestic companies, including Petrobras, the world’s largest deep water oil producer. It’s scheduled to invest $236 billion over the next five years in energy development.
All of this private and public stimulus should help keep unemployment from rising much if at all. But we think the bigger payoff will come over the next several years, as Brazil begins massive infrastructure development to ready itself as host to the 2014 World Cup and the 2016 Summer Olympics. The country has slated nearly $500 billion in projects encompassing roads, factories and airports. For example, it’s expanding the country’s largest airport from two to three terminals, as well as building two hotels in the airport’s vicinity, to accommodate the World Cup. Given what’s occurring in Mexico and Brazil, it’s enough to make one chant, “Ole Ole Ole Ole!”
