Good News For 2019: Mexico’s New President AMLO Is Scaring Wall Street.
Mexico’s new president Andres Manuel Lopez Obrador (aka AMLO) is merely two weeks in and he’s already making investors worried. That’s potentially great news if AMLO does exactly the opposite of what investors think he will do.
This isn’t a political junkies story. This is for the bond lords of emerging markets from New York to London who love a good old-fashioned political drama in Latin America, especially the kind that leads to mispricing.
Rewind the clock a bit, to October 2002 in Brazil. It’s Luiz Inacio Lula da Silva in a landslide against status quo, pro-IMF, business-friendly Jose Serra. Brazil’s currency, the real, trades over R$4.30, its weakest level ever. Foreign investors are in a panic mode not seen since the currency was depegged from the dollar. They think Lula is the next Hugo Chavez or something and they’re out of there.
Instead, Lula proves to be pragmatic. He’s not some leftist dictator who is going to reorganize the economic policy making institutions to look like they were designed in Havana. Within his tenure, the real strengthens incredibly, hitting around R$1.55 to the dollar. Brazil becomes investment grade.
Lula was the opposite of what the market feared. If AMLO can be like Lula, Mexico is a buy.
The problem is, that idea is already starting to dissipate.
“I was in Mexico City a couple months ago and a few of AMLOs people spoke to us and were really working hard to reach out to market participants and investors,” says Nathan Sheets, an economist with PGIM Fixed Income and a former Obama Treasury official. “I think you got this ‘oh, he can be like Lula’ feeling back in September when they were promising us a disciplined budget.”
AMLOs preliminary three-year budget comes out on Saturday, Dec. 15. It will set the tone for Mexico.
“Investors are a bit nervous now about whether this administration can pursue market-friendly policies,” says Sheets. “We have to read the tea leaves. For a while they were good, now they are not as good.”
Everyone knows why they are not as good. AMLO promised to put an airport construction project up for a referendum vote: up or down, yea or nay. The nays had it. The airport project was killed and AMLO was a bit slow in affirming bond holders would be paid.
Then a member of his party, the social-democratic National Regeneration Movement (MORENA), said the party will limit banking fees on things like checking accounts.
“AMLO rejected that idea, which was an important thing for him to do, but now it’s stuck in our head as a potential risk,” says Phillip Torres, global co-head of emerging markets for Aegon Asset Management. “Sure the government said it will buy back the airport bonds, but that comes in exchange for giving up certain rights as bond holders and the bond holders group rejected that offer. This is not starting off good for Mexico.”
Since AMLO was elected on July 1, the peso has remained steady, trading between 20.60 and 20.26. It’s been as strong as 18.5 after his win, so the peso has lost its shine the closer one gets to his taking office on Dec. 1.
On the equity side, the iShares MSCI Mexico (EWW) is down only around 2% since he took office. It’s down nearly 10% since he was elected, which is still better than the MSCI Emerging Markets Index.
“Mexico is only outperforming because of the new NAFTA deal,” says Brian Nick, chief investment strategist at Nuveen. “It’s why we are positive but cautious. Honestly, I’d take Brazil over Mexico if I had to pick a spot in Latin America.”
For stocks and bonds heading into 2019, Mexico is a neutral weight at best, underweight for most. AMLO is largely to blame for this. But it is that uncertainty that creates opportunities as risk-averse investors prefer to take money off the table then get beat up by the policy surprises of a new president.
“We did a thorough analysis of Mexico two months before the election, lightened up on it afterwards and certainly have put no new money in Mexico since,” says Theresa Barger, CEO, and co-founder of Cartica, an emerging markets investment firm.
She says that AMLO’s version of direct democracy — putting everything up to a vote — versus representative democracy, means he has tied his hands to an electorate that will, naturally, want everything that the government puts up on offer. More money for schools? Check. More money for healthcare? Check. Bridges and roads? Yes, and yes.
AMLO swept into power on the electorate’s disdain for a corrupt ruling elite and a nasty drug war. He said that he will cut government spending by reducing corruption and crony capitalist projects, sort of like the airport that got voted down recently.
On one hand, Mexican business owners say that if he can crack down on crime and corruption, then they will take a little bit of policy headwinds next year. On the other, Mexico’s biggest investors in the U.S. think AMLO has set himself up for disappointment. He has had a harder time picking from Mexico’s qualified technocrats in the Finance Ministry and elsewhere to run key positions. His central bank pick is a former HSBC chief economist named Jonathan Heath.
Back to the Lula analogy…
“AMLO doesn’t seem to care what the market thinks about his programs,” says Barger.
If AMLO turns out to be like Lula, it’s a win for Mexico. The biggest crystal ball problem for AMLO is that Lula was undone by his own corruption and is now in prison. So pro-tip, Senor Presidente, only take the best of Lula.
Bryan Carter, head of emerging markets fixed income at BNP Paribas Asset Management in London, thinks AMLO is not like Lula at all.
“Lula maintained the fiscal anchor,” he says about his economic prudence. Lula’s predecessor, Dilma Rousseff, hoisted that anchor and set sail. It led to her bon voyage, as in her impeachment. She was kicked out of office early in her second term.
“Dilma threw out the fiscal anchor. AMLO, on the policy front, is more like Dilma: changing the whole rubric of the economy is a big deal,” says Carter. “AMLO has pledged to raise the minimum wage, lower government prices, and promised fiscal spending on infrastructure,” he says, then pointing out some of Dilma’s errors and the corruption scandals and how it all led to a nasty two-year long recession in Brazil. “Maybe comparing him to Brazil is a bad idea.”