2018, a year of big definitions for Mexico, what can we expect, where do we see risks and opportunities?
Dear Investor:
It is my pleasure to address you again at the start of this year and before we start I would like to wish you a great 2018, a year that without a doubt will be filled with great challenges and difficulties, but with great opportunities as well, our country will definitely be closely watched by the entire world, not only because of our presidential elections but also awaiting the definition of NAFTA, both events will define the future of our country for the next 6 years. And, what can we expect from the international markets? Will the global rally in stock markets continue? Are the consequences of the 2008 financial crisis over and can we start to think about sustained economic growth in the US, Europe, China and the rest of the world? What will happen to the peso-dollar parity? These are just some of the questions that we all have in mind, and in a brief and clear manner I would like to share in this document Actinver Group’s vision and our precise recommendations that we have for your savings and investments. Let’s go part through part…
MEXICO: The 2 great obstacles and their repercussions
As expected, the 2 big events that will occur in our country during the first 6 to 8 months are NAFTA re-negotiations and the presidential election. There is a lot at risk and depending on the outcome of these two events, the markets will move, and they will move a lot, both positively and negatively. But why is there so much at risk? NAFTA: This agreement has become an important pillar for the Mexican economy, and its continuity would grant certainty to investors and contribute to the development of our country. Its withdraw, on another side, could create great uncertainty and would, to start, put a brake in direct foreign investment in the short term. Presidential Election: The thing in question here is the continuity of our economic model and the approval of structural reforms (PRI-PAN, whoever wins is irrelevant) or gambling on a different model where we would again go into uncertainty, where the continuity of structural reforms, the cancellation of projects and infrastructure works would be questioned (AMLO with Morena) with the promise of a new model that would bring social peace and eliminate corruption. These are the 2 great challenges and decisions that our country will have to go through and decide, and it is necessary to give probability of occurrence to each one of them. At Actinver, with the information that we have at the beginning of the year, these are the probabilities that we
foresee for each event:
Probabilidades de Ocurrencia:
|
yes |
no |
NAFTA |
60% |
40% |
AMLO |
50% |
50% |
As you can see, the probability of occurrence for each event is really uncertain, but the combination of both is what will really move the markets, and regarding the aforementioned probabilities, combining both events, we have the following estimates for the key economic variables of our country and financial assets:
|
TLC si / AMLO no |
TLC si / AMLO si |
TLC no / AMLO si |
TLC no / AMLO no |
Prob. Asignada |
30% |
30% |
20% |
20% |
IPC |
60,000 |
54,000 |
42,000 |
46,000 |
Dólar vs Peso |
16.8 |
19.1 |
21.6 |
19.5 |
Bono a 10 años |
6.80% |
7.50% |
8.20% |
7.30% |
Tasa de fondeo |
6.75% |
7.50% |
8.25% |
7.75% |
PIB |
2.80% |
2.40% |
1.90% |
2.10% |
NAFTA – what should be considered?
In our point of view, the resolution of NAFTA will be this year’s most important even in terms of possible repercussions on financial assets. The continuation of the Agreement could position Mexico as one of the most attractive emerging markets and we might easily see a strong appreciation of the peso and an IPC that, in the worst-case scenario (with AMLO winning the elections), would advance 10%. Our most favorable scenario (NAFTA continues and AMLO doesn’t win) would drive the IPC to 60,000 units and the exchange rate below $17 pesos by the end of the year. This obeys the reaction that we expect from the investors, which would rapidly start to evaluate the possibility of our economy growing over 3%, with structural reforms that would start to take effect and with jurisdictional certainty for direct foreign investment, Mexico would be an absolute buy. On the other hand, if the United States decides to exit the agreement, uncertainty would dominate in the investment field and although trade would not suffer much (OMC rules would be used) the halt to investment would cause a strong downfall in IPC (we calculated a value just under 46,000 units, but if it happens in conjunction with an AMLO victory, the indicator could even reach 42,000 due to the additional uncertainty that would be created, namely with the structural reforms). With a cancelled NAFTA, the peso would also suffer and would possibly direct to the highest levels that we observed last year, close to $22. Regarding monetary policy, we also see 2 very different scenarios, as with NAFTA Banxico would not have to continue raising its interest rates (the exchange rate would help out with the expected appreciation) and on the contrary, without NAFTA, the markets’ reactions would surely force Banxico to raise its rates to levels possibly above 8%.
Some good news about NAFTA is that we will have an idea about the direction that it will take as soon as January, the 6th round of negotiations will be held from the 23rd to the 28th of the first month of the year and this 6th round will truly be crucial. In case that the round ends and there is an agreement to continue with the negotiations, this would be a magnificent signal, and the markets would possibly start to react again, since it is precisely the 6th round where the most critical issues will be addressed (rules of origin, termination clauses, and trade deficits). Our base scenario is that NAFTA will be maintained, however, we do consider a high probability that Mr. Trump decides to send a termination order as negotiation tactic. This does not mean that NAFTA would automatically be cancelled, and if it did, our scenario is that the US’ laws would force the Congress to get involved and eventually, the decision to stay or exit would come from Congress, our scenario is that Congress would vote to stay. However, this process may take over 1 year, time in which the markets would turn highly volatile. It is due to this assumption that we assign a 40% chance not necessarily to a termination, but to a period of uncertainty that would greatly harm us.
Presidential Election, what should be considered?
The result of the Presidential Election is, to this day, a true coin flip between AMLO or any of the other two candidates winning. As we had previously mentioned, PRI or PAN means continuity, while AMLO would mean uncertainty in the short run to the eyes of investors. What’s important to highlight is that regardless of who wins, the impact on the markets in 2018 won’t be as important as NAFTA negotiations. And, why do we dare make this observation? Because in the case of an AMLO victory, we believe that he would immediately have a conciliatory speech, that will calm the markets after the 1st of July, and since he wouldn’t enter into office until December, practically all of 2018 would focus on the NAFTA resolution. This is our generalized vision, but this does not exempt us from the great volatility that will occur before the elections (we consider that it will start during April), where we will surely see the exchange rate and the IPC move depending on the on the outcome of the polls. A fact worth mentioning is that, studies from previous elections where the leftist candidate ended up winning (Brazil, Peru, and Argentina, to mention a few) show that one month before the day of the election, the local markets reach the lowest points in both the exchange rate and the respective stock exchanges, and from that month and immediately after the presidential elections (with the leftist candidate being the winner), the markets not only recovered but they also experienced an important rally in the subsequent months. We do not rule out that this scenario occurs in Mexico, under our scenario of a conciliatory speech in the case of an AMLO victory. If PRI or PAN were to win, as we previously explained, the rally would be much stronger.
And for the international financial markets what can we expect?
After an almost uninterrupted rally in the US’, Europe’s and Asia’s stock markets during 2017, the great question is whether this will continue in 2018. The global economy has certainly improved and the effects from the great crisis of 2008 have practically been forgotten, and this economic growth is expected to continue going forward as conditions support this scenario: interest rates are still considerably low, low inflation, fiscal stimuli in the United States, a healed financial system and employment in frank recovery. This makes us think that 2018 could again be a good year for stock markets all around the world, and we agree on this last statement as we consider that the S&P should increase in line with the companies’ profits (the last figure of analysts’ estimates is an 8% growth in profits). However, we would like to highlight some risks that may cause a 10% to 15% adjustment:
Inflation: Certainly, inflation has not been a factor in the last 10 years, and there were even serious concerns of deflation at some point. However, US economy already
begins to show signs of overheating and inflation could rebound, forcing the Fed to be more aggressive in its upward cycle of rates.
The Central Banks: Don’t forget that we are still in an environment of very high monetary stimulus, and to this day, the movements of the FED, the ECB, the BOJ and the BOE have all been correct. This does not exempt anybody from committing a monetary policy error (especially with a new head at the FED). Over-raising the rates would provoke undoubtedly an adjustment in the markets.
Geopolitical problems: The issue of North Korea is still unsolved, and we think that during this 2018 we will have another moment of high tension. A miscalculation of any of the parties involved could cause a very violent and aggressive "risk-off" in international markets.
There are no "surprises" left: 2017 was characterized as a year in which economies surprised the market in a positive way. Now, market expectations are high, and in case of not reaching those expectations, due to the high valuation levels a quick and violent profit taking could be triggered.
What investment recommendations do we have for 2018? Given all the scenarios mentioned above, and considering the complexity of the environment and the multiple options that arise depending on the scenario that materializes, it is necessary to divide this 2018 into 3 parts: 1st quarter, 2nd quarter and second half of the year:
1st quarter of 2018:
This will be the key quarter of the year, because we will have the definition of NAFTA, amidst this environment, we recommend the following:
In Fixed Income: Maintain positions in stable and defensive products, which will not be affected in case of a negative resolution. These products will tend to pay the overnight rate of Banxico, which is currently at 7.25% (not bad for a risk-free investment). We recommend ACTIMED, ACTIVCO and ACTIVIDA as part of our fund offer, and keep a position between 10% and 20% of your portfolio in dollarized funds such as ACTIPLUS, ACTICOBER and ACTOTAL as an insurance.
In Variable Income: Reduce exposure to an underweight level in your portfolio, on levels of 50,000 points in the benchmark index. We consider that the benefits do not compensate the possible risks. If NAFTA resolution is favorable, there will be time to reinvest the money and take advantage of the rally that we expect for Mexico. The products that we think will be more defensive will be those that are not indexed, as they are somewhat lagged in their valuations. Specifically, we recommend the ABSOLUTO and EVEREST funds, since their active management will significantly reduce risks and protect capital, and in funds of 100% variable income, we recommend the OPTIMO, MAYA, ACTICRECE and DINAMO funds (this latter being multiasset dollarized). For the most aggressive investors, we see the ACTINEM fund with enormous potential (it has high exposure to Brazil, a country that we believe will continue performing splendidly for several more months).
2nd quarter of 2018:
Negative resolution for NAFTA: Maintain the exposure to fixed income through ACTIMED and ACTIVCO and in dollarized funds, and even increase the exposure to dollars in 10% more of your portfolio. For Mexican equities we would recommend sell until we see the benchmark index at 46,000 points.
Positive resolution for NAFTA:
In Fixed Income: There will be a rally in rates and funds with exposure to longterm bonds, they will perform very well. Here we would recommend changing ACTIMED for ALTERNA and MAXIMO funds, and hold ACTIVCO; as its active management will allow a correct positioning. Under this scenario we also recommend reducing exposure in dollars, as the rally of the peso could be significant, despite the elections that are around the corner.
In Variable Income: We practically recommend buying any Mexican product with exposure to equities, MAYA, ACTIVATE, OPTIMUM and ABSOLUTE AND EVEREST FDFs.
2nd Half 2018:
As of July 2, we will have the answer to the 2 key issues for Mexico, and according to the scenarios table described above and emphasizing that the outcome of NAFTA will be much more relevant than the presidential election. Overall, we recommend the following:
Scenario TLC yes / AMLO No:
Strongly overweight the Mexican Stock Market, through any of our funds ACTIVAR, MAYA, OPTIMO, ACTICRECE, EVEREST. Sell Dollars and buy aggressive fixed income funds, ALTERNA and MAXIMO.
Scenario TLC yes / AMLO yes:
Lightly overweight the Mexican Stock Market, with a horizon only of 2018 (we won’t know the actual policies of AMLO until 2019). Hold funds in Dollars and Hold ACTIMED and ACTIVCO in fixed income.
Scenario TLC no / AMLO yes:
The worst possible scenario, sell Mexican equities, hold ACTIMED, ACTIVCO and short term fixed income products as promissory notes, cetes and conservative portfolios, overweight dollars in ACTIPLUS, ACTICOBER Y ACTOTAL.
Scenario TLC no / AMLO no:
Sell Mexican equities and wait for levels around 46,000 to enter, maintain dollars and slightly buy more aggressive fixed income funds ALTERNA Y MAXIMO.
Finally, we reiterate our recommendation to always have a well-diversified portfolio, because history has proven that a portfolio that has "a little bit of everything" not only reduces investment risks but also increases returns.
Yours,
Alonso Madero
CEO, Asset Management.
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