Look South For An Emerging Markets Rebound Play
There has been ample chatter about the wide gap between the S&P 500 and emerging markets equities.
And while the MSCI Emerging Markets Index is inexpensive on a valuation basis, that has not been luring buyers into developing world stocks this year. A gain of 20 percent for the SPDR S&P 500 (NYSE: SPY) and a 12 percent loss for the iShares MSCI Emerging Markets ETF (NYSE: EEM) proves as much.
Forecasts stating the obvious, the obvious being emerging markets are cheap, have increased over the past couple of months, but that has not really done much for the broader developing universe. In the past 90 days, SPY is up 4.1 percent while EEM is off 11.7 percent.
The Vanguard FTSE Emerging Markets ETF (NYSE: VWO), which excludes South Korea is down 12.7 percent since May 8. If those declines are good for anything, it is to increase chatter regarding an emerging markets rebound. However, investors may do well embrace past leaders that continue to look pricey relative to the downtrodden likes of India, Russia and South Korea.
Related: Good News: Emerging Markets Are Cheap.
Enter Mexico and the iShares MSCI Mexico Capped ETF (NYSE: EWW). EWW has previously been an emerging markets leader, particularly among single-country Latin America ETFs. In the past year, EWW is the only member of a group that includes the iShares MSCI Brazil ETF (NYSE: EWZ), the iShares MSCI Chile ETF (NYSE: ECH) and the iShares MSCI Peru ETF (NYSE: EPU) to generate positive returns. Yes, the Global X FTSE Colombia 20 ETF (NYSE: GXG) is up 0.4 percent in the past 12 months, but that pales in comparison to EWW's almost 10 percent gain.
Over the past three months, the almost $2.4 billion EWW has again outpaced ECH, EPU, EWZ, EEM and VWO by wide margins. The issue for investors looking for bargains is that Mexico is not the emerging market for fans of deep discounts.
Partially the result of a more than 44 percent combined weight to defensive sectors consumer staples and telecom, EWW has a P/E ratio of 27.3 and a price-to-book ratio north of six according to iShares data. By comparison, EWZ's P/E is 19.6 and ECH's price-to-book is barely above two. The MSCI Emerging Markets Index trades 10 times forward earnings.
EWW and its 49 constituents are not free of risk. Mexico's deep trade relationship with the U.S. and proximity to the world's largest economy have exposed an intimate correlation of Mexican stocks to Federal Reserve tapering chatter.
Additionally, some analysts believe Mexican stocks must decline further before becoming truly attractive. "The recent sell-off in Mexican equities does little to change our cautious view. The stock market continues to trade well above 1.5 standard deviations relative to its own historic average and indeed relative to the universe of global emerging equities (GEM) across a number of measures (trailing PE, forward PE and P/BV)," said UBS in June.
And no investor should ignore the fact that on Wednesday, the Bank of Mexico slashed its 2013 GDP growth estimate to two percent to three percent from three percent to four percent. The central bank also cut its estimate for the number of formal private-sector jobs that are likely to be created this year by 100,000 to a range of 450,000 to 550,000, The Wall Street Journal reported.
The bullish view includes Mexico undercutting China on productivity-adjusted manufacturing costs. Obviously, a U.S. company that prefers to outsource manufacturing labor will save on transportation costs with Mexico compared to China. Mexico also has more free trade agreements than any other country in the world.
Additionally, Mexico is looking to spend $316 billion on infrastructure projects in the coming years. President Enrique Pena Nieto is looking to reform Mexico's banking system, one that is not as vibrant as what is seen in other Latin American countries such as Chile.
Here is a clue that some investors are already betting on Mexico being an emerging markets leader once again: In July, investors poured $210 million into Mexico ETFs, according to BlackRock data. That may not sound like a massive number, but consider that about $1.8 billion combined was pulled from China, Brazil and India funds.
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