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Today’s Featured Topic

Mexico’s President-Elect Wins Sweeping Mandate to Reshape the Country

SUMMARY: Seismic changes lie ahead for Mexico with the election of Andrés Manuel López Obrador as the country’s next president. Whether the Mexican economy under AMLO goes the way of Venezuela under Hugo Chavez or Brazil in the initial years of Lula’s presidency remains to be seen. Two areas that will surely be disrupted are energy and trade. 

Yesterday, Mexicans voted resoundingly against the establishment by electing left-wing populist Andrés Manuel López Obrador (“AMLO”) as their next president. He will be sworn into office on December 1, 2018. This was the largest election in Mexico’s history, with some 3,400 federal, state and local races contested in all, so there will be changes at the federal, regional and local level.

ALMO’s victory is a political earthquake in a country where almost all voters alive today have never been governed by a president who was not either from the PRI or PAN, the two parties that have dominated Mexican politics for the past 89 years. Moreover, he could become Mexico’s strongest president in more than 30 years if it turns out that his MORENA party has captured a majority in both houses. Just like with the Macron election in France last year, the majority would give AMLO enough power to push through his plans with little interference.

CURRENT CONDITIONS

Until the 1980s, Mexico was an inward-looking state ruled by a single party. Then, subsequent presidents undertook some transformative initiatives such as joining the global trade regime, privatizing state enterprises, creating the framework for transparent competitive elections, and other market-friendly measures that opened up Mexico’s economy and markets to the world. Those changes lifted Mexico from an economy dependent on oil exports to a manufacturing powerhouse with a rising middle class.

But the country’s improved prosperity has not benefited everyone equally, and economic growth has been modest. GDP has expanded at a tepid annualized rate of 2.5% over the past six years, inflation-adjusted wages have been stagnant, and the poverty rate has risen from 32% in 2006 to 39% last year. Foreign direct investment dropped from $3.9 billion in 2012 to about 500 million in 2017. And, because of rampant corruption, Mexico is now ranked 135th out of 180 countries in the corruption perception index of Transparency International, worse than Sierra Leone and alongside Russia and Paraguay.

At the same time, Mexico’s crime rate has spiraled out of control, leading some firms to pull out of the most affected areas. In May alone, nearly 2,900 people were murdered — roughly 4 victims per hour. There have been 13,298 registered homicides YTD, a 21% spike on the same period last year, and over 200,000 lives have been claimed by violence since 2007. The mere act of running for local office has been a death sentence for many. Since campaigning began in September 2017, over 130 political candidates have been killed, most commonly due to their unwillingness to comply with Mexico’s powerful drug cartels.

AMLO has vowed to tackle the poverty, violence, and corruption and to give more attention to the domestic economy. Some of his stated plans, such as building oil refineries and trying to achieve food self-sufficiency, signal a bigger economic role for the state going forward.

ECONOMIC POLICY

AMLO avers that he would lead a market-friendly government — without tax increases, new taxes or an increase in public debt — respect the independence of the central bank, and maintain the free-floating peso. During his tenure as Mayor of Mexico City from 2000 to 2005, he acquired a reputation as an economic pragmatist and fiscal hawk.

His proposals to fight poverty center on increased social spending and public investment, including a public-works program to employ 2.3 million young people, a plan to double the retirement pensions of the elderly, guaranteed food prices for small farmers, and subsidized gasoline prices.

AMLO intends to pay for all this, not by raising taxes, but with the $25 billion a year he will purportedly get by ending corruption, and $20 billion more a year he will save through an austerity plan. He aims to balance the budget in three years by scrapping government employee perks, ending inefficient social programs, and halving civil servants’ pay.

The estimated cost of these projects is about 2.5% of GDP. Expectations of success are mixed, but most economists are skeptical the sums add up, given that Mexico already runs a budget deficit that’s about 2.5% of GDP. Rafael Elias, an analyst at emerging markets investment bank Exotix, suspects “finances would be much less orthodox, public spending would balloon, current account would deteriorate, and perhaps we could even see a ratings downgrade as public finances worsen.” This scenario would lead to a weaker currency, falling FDI, capital flight and perhaps a recession. In other words, AMLO will likely face a choice between scaling back his promises or taking on debt, possibly damaging Mexico’s hard-won financial stability.

Not everyone is pessimistic. These optimists believe AMLO will transition from a redistributive candidate to a staunchly middle-class president who will soften his leftist stance. They draw parallels between him and Luiz Inácio Lula da Silva (“Lula”), Brazil’s former president. Lula too had radical leftist views prior to election, but reversed policies once in office, and ended up presiding over a business-friendly economic boom, albeit a short-lived one. But, skeptics point to differences between AMLO’s and Lula’s business experiences and philosophies that would suggest otherwise.

Whether Mexico ends up going the way of Venezuela under Hugo Chavez or Brazil in the initial years of Lula’s presidency remains to be seen. Two areas that will surely be disrupted under AMLO are energy and trade.

OIL

For decades AMLO has described Mexican oil reserves as the property of “the people,” meaning the government. He has also said that Mexico will have an “open door” for private investment in everything except energy. It is therefore highly likely that he will roll back energy reform. The oil tenders that began under Peña Nieto will be paused while more than 100 contracts are examined. Oil companies have so far put $4bn on the table, with as much as $200bn of investment to follow. But, this will probably be put on hold as well. The net effect will be less Mexican oil flowing into global markets. AMLO has also suggested that Mexico should re-build its oil refining capacity, a proposition unlikely to find private sector support. 

TRADE

AMLO maintains that he will continue negotiations to revamp NAFTA. He is expected to take a hardline position in areas like agriculture and manufacturing to gain credibility with his base, and has expressed a willingness to walk away from the talks if he feels Trump has gone too far. If that happens, he would have to quickly secure new partners, as trade agreements are a big reason for Mexico’s success. Notably, 81% of Mexico’s exports went to the United States last year. If NAFTA was torn up, Oxford Economics estimates that Mexico’s GDP would lose 4 percentage points by 2022 and fall into a technical recession by mid-2019. The Mexican peso would fall further to around 23 to 25 per dollar from its current value of 19.72 pesos per USD.

Mexico, with a GDP of $1.1 trillion, is Latin America’s second largest economy and the 15th largest in the world in nominal terms. The country has enjoyed an unprecedented period of macroeconomic stability, which has reduced inflation and interest rates to record lows and has increased per capita income. With this disruptive election result, the BIG question is whether the nation’s transformation into a modern, advanced democracy can withstand a six-year term under a leftwing government. Investors can take a bit of comfort in the fact that major economic reforms would have to be preceded by congressional votes or referendums. That would give market participants some time to evaluate their options before the grounds shifts further underneath them.

Investors can gain exposure to Mexico’s equity markets via the iShares MSCI Mexico Capped ETF (EWW). The ETF has underperformed the S&P 500 (SPY) by 12 percentage points since MRP’s April 2 DIBs report titled Mexico’s Economic Model Could Shift After July 1

We’ve also summarized the following articles related to this topic in the POLITICS & POLICY section of today’s report.

  • Leftist Wins Mexico Presidency in Landslide With Mandate to Reshape Nation 
  • Mexico: Mexico’s Presidential Watershed
  • Mexico: Mexico’s presidential front-runner could shake up Trump and NAFTA
  • Mexico: Amlo as Lula?

 

Chart: Mexico (EWW) vs Latin America (FLN) vs Emerging Markets (EEM) vs S&P 500 (SPY)

 

Other Disruptive Change

Markets

  • Bonds: Junk Debt Is Outdoing Its Peers
  • Digital Currencies: Digital currency sales hit $13.7 billion in first five months of 2018
  • Gold: Why Russia and Turkey Are Such Gold Bugs 
  • Stocks: China Think Tank Warns of Potential ‘Financial Panic’ in Leaked Note
  • Stocks: Wall Street Left Reeling as 2018 Upends Almost Every Bet

Economics & Trade

  • Inflation: U.S. Inflation Hits Six-Year High in May
  • Inflation: Surging oil prices send eurozone inflation above ECB target 
  • China FDI: China Opens Up More of Its Economy to Foreign Investors
  • Trade War: Trump reportedly wants the US to withdraw from World Trade Organization

Labor, Education & Demographics

  • Immigration: Private sector profits from immigration enforcement

Services

  • Video Games: Video Game Stocks Are Potential Media Company Acquisition Targets
  • Waste: China’s scrap ban demands new game plans for steel companies

Technology

  • Robotics & Automation: Farmers Insurance Tests AI, Automation’s Potential For Speeding Up Claims Process

Transportation

  • Electric Utilities: How a 29-year-old is using blockchain and A.I. to cut energy bills by up to 25 percent

Commodities

  • Refiners: Crack Spreads Move Lower, A Warning For Refining

Energy & Environment

  • Nuclear: Nuclear Fusion Power Could Be Here By 2030, One Company Says

Biotechnology & Healthcare

  • Genomics: DNA ‘barcode’ delivering personalised breast cancer care
  • TelePharma: Hair-Loss and ED Drugs Startup Hims Raises Another $50 Million

Endnote

  • Payments: This map shows how much debit card use has declined in the US

 

Joe Mac’s Market Viewpoint

Top 

 

 

 

CAPEX Booms!

The Federal Reserve has said for years that it wants to get inflation in the U.S. back to 2% per year. Some indicators are already showing inflation rates higher than that. But, the Fed persists with its fixation on the core personal consumption expenditures (“PCE”) deflator as a superior measure. That number has been stuck below 2% since May 2012. The trend of the inflation data, however, may be changing soon.

Joe Mac’s Market Viewpoint: CAPEX Booms! 

 

Other Viewpoint Reports

Joe Mac’s Market Viewpoint: The Inflation Complication 

Joe Mac’s Market Viewpoint: A Review of MRP Themes 

Joe Mac’s Market Viewpoint: The Coming Value Rotation 

Joe Mac’s Market Viewpoint: Beyond the Bond Bubble 

 

Current MRP Themes

Top 

 

 

 

Autos (S)

 

Electric Utilities (L)

 

TIPS (L)

 

 

 

Long-Dated UST (S)

 

Defense  (L)

 

Industrials (L)

 

 

 

Materials (L)

 

U.S. Financials & Regional Banks (L)

 

ASEAN Markets (L)

 

 

 

Oil & U.S. Energy (L)

 

France (L)

 

Greece (L)

 

 

 

Saudi Arabia (L)

 

Palladium (L)

 

U.S. Pharmaceuticals (S)

 

 

 

Gold & Gold Miners (L)

 

Robotics & Automation (L)

 

Video Gaming (L)

 

 

 

Lithium (L)

 

Steel (L)

 

Value Over Growth (L)

 

 

Solar (L)

 

CRISPR (L)

 

Obesity (L)

 

Major Data Points

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1.

 

US Personal Spending Rises Less than Expected

Personal spending in the United States rose 0.2 percent month-over-month in May of 2018, following a downwardly revised 0.5 percent gain and below market expectations of 0.4 percent. It is the smallest increase in personal spending in four months, mainly due to a drop in outlays on household utilities. TE

 

2.

United States Consumer Sentiment

The University of Michigan’s consumer sentiment for the US stood at 98.2 in June 2018, compared with a preliminary reading of 99.3 and slightly above May’s 98. Both consumer expectations and current economic conditions came in weaker than initially thought. Inflation expectations for the year ahead rose to 3 percent in June from 2.8 percent in May, above a preliminary 2.9 percent. The 5-year outlook for inflation increased to 2.6 percent from 2.5 percent. TE

 

3.

 

Japan Consumer Confidence

The Consumer Confidence Index in Japan edged down to 43.7 in June of 2018 from 43.8 in the prior month and below market consensus of 43.9. Consumer Confidence in Japan averaged 42.25 Index Points from 1982 until 2018, reaching an all time high of 50.80 Index Points in December of 1988 and a record low of 27.50 Index Points in January of 2009. TE

 

4.

United Kingdom GDP Annual Growth Rate

The gross domestic product in the United Kingdom expanded 1.2 percent year-on-year in the first quarter of 2018, unrevised from the second estimate and following a downwardly revised 1.3 percent growth in the previous period. It was the weakest pace of expansion since the second quarter of 2012, due to a slowdown in both household consumption and fixed investment. TE

 

Other Disruptive Change

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Markets

Bonds: Junk Debt Is Outdoing Its Peers 

High-yield, or junk bonds, are closely geared toward the strength of the U.S. economy. With U.S. growth picking up and business confidence soaring, high-yield bond prices are holding steady even as the Federal Reserve has signaled it is leaning more aggressively on its path of interest-rate increases. When rates are rising, bond prices often tumble as investors adjust to rising yields in benchmark debt.

The gap between yields on junk bonds and those on U.S. government debt has narrowed this year, even as the spread between highly rated debt and Treasurys has widened. The Bloomberg Barclays U.S. Corporate High Yield index has posted a total return of 0.7% this year, counting price changes and interest payments, ahead of the 3.6% drop for investment-grade corporate debt and the 1.4% decline for Treasurys.

With the Fed on track to raise short-term rates twice more in 2018, some investors are turning to high-yield bonds to cushion the blow to their portfolios. Shifts in global investment flows have hurt investment-grade debt without hitting high-yield bonds, some analysts said. Over the past few years, investors in Europe and Asia had piled into bonds from U.S. companies because their yields were higher than U.S. government debt. Steady economic growth made investment-grade corporate debt sufficiently safe for overseas investors. The 2017 tax overhaul also hit investment-grade bonds more than high-yield debt by cutting taxes on companies repatriating overseas earnings.

That leaves some investors worried about potential losses if the economy turns or oil prices drop again. While the high yields on junk bonds can insulate holders from the gradual course of Fed rate increases, prices can fall sharply during times of stress, such as in the recessions of 1991 and 2008. WSJ

Digital Currencies: Digital currency sales hit $13.7 billion in first five months of 2018

Digital currency sales jumped to $13.7 billion in the first five months of the year, nearly double the amount raised for the whole of 2017. This year’s virtual currency sales from 537 coin offerings topped last year’s total of $7.0 billion, and included mammoth offerings from Telegram, a messaging service founded by Russia-born entrepreneurs Pavel and Nikolai Durov in 2013, and Block.one’s EOS currency, the report said.

The report also said of the 3,470 ICOs announced since the first token offering in 2013, only 30 percent of those have closed successfully, while many have been delayed, or lost momentum during the ICO process, the report noted. The United States remains a leading destination to host ICOs, with 56 token sales registered raising $1.1 billion in the first five months of 2018, reinforced by “clear and firm regulatory requirements,” the report said. R

Gold: Why Russia and Turkey Are Such Gold Bugs 

Since December 2017, Russia has cut its holdings of U.S. foreign debt by more than half. Instead, it’s been increasing the share of gold in its international reserves. That’s understandable behavior for a country that has to deal with an unpredictable U.S. sanctions policy, but it’s also part of a trend. Foreign governments and international organizations account for a decreasing share of outstanding U.S. debt, and some economies have in recent years aggressively upped the share of gold in their reserves instead.

Russia, Kazakhstan and Turkey account for 50 percent of net gold purchases by central banks in the last five years. But large European economies, which have long kept most of their international reserves in gold, have mostly held their share steady rather than invest more in dollar-denominated assets. The euro area, including the European Central Bank, holds 55 percent of its total international reserves in gold, just like in 2008.

Central banks — primarily those of the gold bug authoritarian states — bought 116.5 tons of gold in the first three months of 2018, the most in any first quarter since 2014 and up 42 percent year on year. For Turkey as for Russia, the decision to reduce holdings of Western currencies appears to be strategic. Like Russia, Turkey has recently moved quickly out of U.S. debt, cutting holdings by almost 38 percent to $38.2 billion since October, 2017. B

Stocks: China Think Tank Warns of Potential ‘Financial Panic’ in Leaked Note

A leaked report from a Chinese government-backed think tank has warned of a potential “financial panic” in the world’s second-largest economy. Bond defaults, liquidity shortages and the recent plunge in financial markets pose particular dangers at a time of rising U.S. interest rates and a trade spat with Washington, according to a study by the National Institution for Finance & Development. The think tank warned that leveraged purchases of shares have reached levels last seen in 2015 — when a market crash erased $5 trillion of value.

Chinese stocks entered a bear market this week, with the benchmark Shanghai Composite Index falling more than 20 percent from its January high, while the yuan has slumped more than 3 percent in the past two weeks. The currency dropped to the lowest level since December on Wednesday.

NIFD said China had failed to address the issue of leveraged stock purchases, a major contributor to the market collapse three years ago. Such wagers have reached about 5 trillion yuan ($760 billion), a similar level to 2015. B

Stocks: Wall Street Left Reeling as 2018 Upends Almost Every Bet

Investors breezed into 2018 expecting to pick up easy returns from steadily rising asset prices. Instead, they’re nursing losses on bets that had delivered the biggest gains from a decade’s worth of buoyant liquidity.

Developing-nation stocks are the biggest losers of the year so far, handing investors a loss of 6.8 percent as of Friday, once dividend payments have been taken into account. Emerging-market and euro-denominated debt are close runners-up, with losses of more than 4 percent. Oil was the standout winner as investors bet on tightening supply against the backdrop of the collapse of Venezuelan output and the increased isolation of Iran.

Demand for price protection against large swings in major global equities and currencies is approaching its highest level since March this week. The market’s growth expectations are still too high as trade tensions rattle the world’s two biggest economies, creating ample room for more negative surprises in the next few months. B 

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