EWW - Mexican Stocks Hit 8-Year Highs I Remain Bullish

2023-04-04 05:01:26 ET

Summary

• The Mexican ETF has been one of the world's top-performing country funds in recent months.
• Reshoring is powering the move, and I believe we're in the early innings.
• I am bullish on the Mexico ETF but prefer to own individual Mexican equities with more torque to the manufacturing thesis.

The Mexican stock market has flown under the radar for many years now. The country's stock prices peaked way back in 2013 (at least in dollar terms) and Mexico subsequently experienced a grinding bear market, along with much of broader Latin America.

Commodity prices were an obvious factor in the underperformance, as Mexico is a significant producer of oil and various metals. That said, there was some weakness in the overall NAFTA trading bloc, along with concerns around a potential weakening of ties between Mexico and the United States once former President Trump was elected in 2016.

All this led to what could be viewed as a lost decade for Mexico, both in terms of its weak GDP growth and the poor performance of its equity markets.

However, the tide now appears to be turning. Mexican stocks recently hit fresh new 8-year highs amid a manufacturing boom that is sweeping the northern part of the country. The recent announcement of a major new Tesla ( TSLA ) plant opening in Mexico is just one of many such moves that multinational enterprises are making in 2023.

With Mexico back on the upswing, it's time to take a look at the market and the country's most prominent ETF, the iShares MSCI Mexico ETF ( EWW ).

Mexico: A Glass Half Full

Mexico's stock market now finds itself in an interesting place. Both bears and bulls have a strong argument for their view on the country, depending on the time frame employed. Just look at this chart of the Mexico ETF dating back to 2007:

There is essentially no return here from a price perspective, with dividends being the only source of gains over that time frame. And Mexican stocks are still well off their 2013 all-time highs.

On the other hand, the Mexican ETF has now risen nearly 150% from the March 2020 lows, and it just made new 8-year highs in March. Anyone that has bought into the Mexican stock market in recent years is enjoying excellent returns. That's especially true when considering that so many of the world's other stock markets are stuck in bear markets at the moment. Mexico stands out as a source of strong relative strength.

The Reshoring Boom Kicks In

Mexican stocks were essentially flat in 2022. This was an excellent result compared to almost all other global markets which fell into bear markets last year. And the turn of the calendar has been kind to Mexico as well, with EWW rallying 18% through Q1 of this year.

That 18% gain is particularly impressive in light of the fact that the overall iShares MSCI Emerging Markets ETF ( EEM ) is up just 3% year-to-date. Emerging markets have not reacted well to the dip in commodity prices and concerns around a potential global economic slowdown. And yet, Mexico itself is one of the world's strongest performing markets once again to start this year. What explains the difference?

This gets to my broader thesis that Mexico has decoupled from most emerging markets. Instead of being tied to the fortunes of countries like China or India, Mexico is now primarily a proxy on the strength of the United States. And, in particular, the strength of the U.S.' industrial sector.

Since 2020, we've seen numerous companies move to restructure their supply chains. Globe-spanning networks that heavily rely on far-flung inputs and last-minute deliveries from 10,000 miles away are out of fashion. Instead, companies are looking to build shorter supply chains and encourage more redundancy. That is to say, having multiple places to source materials in case one runs into trouble.

This is fantastic news for Mexico as it is the nearest low-cost economic center to the United States. In addition, only Mexico and Canada are closely connected to the U.S. via high-quality road and rail connections. As we saw in 2020, shipping ports can get backed up during times of disruption. Mexico's high-level of integration into ground transportation networks gives it a big advantage over other economies such as Europe or South America. And companies are taking note.

Just in 2023 alone, in addition to Tesla, we've seen major new factory builds or expansions announced in Mexico across industries including packaged food, steel, electronics, and electrical equipment, among others.

Mexico is moving up the value chain as well, getting higher-prestige (and presumably higher-paying) firms in cutting-edge industries. For one example from just last week, consider Mighty Buildings:

Mighty Buildings Inc. (Oakland, Calif., U.S.) is opening its newest factory in Monterrey, Mexico.

Powered by innovative 3D printing technology that leverages the company's patented composite materials, the new Monterrey facility is capable of producing its components for an entire home during each day of operation, and is focused on scaling the development of Mighty Buildings' homes in the Southern California region, beginning with Desert Hot Springs [...]

The new Monterrey factory is focused on the creation of 3D-printed components for the company's Mighty Kit System, which enables the rapid construction of prefab housing, with the ability to print panels for one to two homes per day. This off-site manufacturing process cuts on-site building time by as much as 50%, the company notes, for completion of a home's envelope in less than one week with near zero waste.

Mexico isn't just doing low-end manufacturing anymore, now it is a player in fields such as, apparently, zero-carbon 3D-printed housing.

This gets at my broader point. Mexico isn't a typical emerging market anymore. Now it is a fully-integrated partner in the North American economic zone. As supply chains shorten, companies will look to keep more and more of their production within North America, and Mexico is the most viable location for the lower-wage part of the manufacturing equation.

As such, Mexico and by extension its currency and equities are now driven by the health of the U.S. and Canadian industrial ecosystem rather than commodity prices or other typical emerging market factors. If you believe, as I do, that North America will continue to take share from other regions in coming years, Mexico is an obvious and inevitable beneficiary of this megatrend.

The Mexico ETF's Top Holdings

As this is an article about the Mexico ETF specifically, I should comment on its individual holdings. Here's EWW's top 10 as of March 24:

The ETF is highly concentrated, with these ten firms making up 65% of the overall ETF.

There are some companies I really like here. But there's also a lot of slower-moving stuff that doesn't really get prime exposure to the reshoring and manufacturing boom thesis. Telecom company America Movil ( AMX ), at 14% of assets, for example, is a stodgy firm that is unlikely to grow much since it already utterly dominates its market. Banks are another big component of the ETF that don't especially excite me. And while Cemex ( CX ) is an industrial company, cement fabrication tends to be a low-margin low-value add part of the supply chain compared to other things.

Many of my favorite Mexican holdings lie outside of the top 10 such as its water infrastructure company, its restaurant chain operator, and its REITs which focus on owning industrial properties such as warehouses which will benefit from reshoring.

I'm bullish on Mexico overall, and thus by extension on the associated ETF. That said, Mexico's stock market is large enough to have dozens of companies with robust business operations and listings with sufficient liquidity to support significant investments. I'd highly encourage investors interested in Mexico to kick the tires on individual Mexican companies of interest rather than just settling for the ETF.

To give one example, airport operator Centro Norte Airports ( OMAB ), which I've covered extensively here at Seeking Alpha , has produced a total return of 350% over the past ten years. EWW, including dividends, has lost 1% over the same period. Centro Norte operates the Monterrey Airport. As Monterrey is arguably the single biggest winner from reshoring, it is prime territory for Mexico's current economic boom. Alas, OMAB stock is not currently within the Mexico ETF's top 10 holdings at present.

All that to say that some diligence into individual names can make a big difference in the Mexican market. Regardless, from a macro perspective, I'm highly bullish on Mexico, and as such, I expect its ETF to continue rising as well.

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