China’s loss is Mexico’s gain

Mexico stands to benefit from the Sino-US trade war and there are clear signs of growing investor confidence in the country, argues John Leiper.

US trade talks with China have stalled. This is because US demands would reduce the Chinese government’s control of the economy, and by extension, the Communist Party’s control of the country. As a result, the trade dispute will roll on and intensify.

Recently, the US removed steel and aluminium tariffs on Canada and Mexico, and delayed levies on EU and Japanese automotive products. In addition, Trump placed Huawei on the export blacklist. It seems that Trump is easing tensions elsewhere to aggressively ramp up pressure on China.

By historical standards, there is certainly scope to do so. Prior to the establishment of the General Agreement on Tariffs and Trade (GATT), the precursor to the World Trade Organization (WTO), global tariffs averaged 40% compared with current US tariffs of 25% on $200 billion of Chinese goods.

A trade war is better for the US than it is for China since China exports more to the US than vice-versa.

Over the years, Chinese subsidies and non-tariff barriers have weakened comparative advantage to the point where there is now significant competition for the manufactured goods currently exported to the US. This makes it far easier to shift global supply chains. As a primary beneficiary of historic manufactured goods outsourcing, China stands to lose from this dynamic.

From a strategic perspective, US companies will come under increasing pressure to shift production out of the country towards a more globally diverse supply chain. This theme has precedent following Japan’s decision to move Chinese-based manufacturing out of the country after the Senkaku/Diaoyu Islands dispute in 2012.

One country that stands to benefit from the Sino-US trade dispute is Mexico. This is because five of the top 10 Chinese exports to the US are also produced in the country. While other countries in Asia may also stand to benefit from export substitution, their close links with China leave them vulnerable to potential economic weakness.

Meanwhile, the removal of steel and aluminium tariffs opens the door to USMCA ratification, which will benefit Mexico greatly, leading to foreign direct investment, jobs and growth.

Attractive valuations also favour Mexican assets. This is because investors remain wary of President Andrés Manuel López Obrador, commonly referred to as Amlo, given his heavy socialist leanings.

Much of this is attributable to Amlo’s decision to cancel work on Mexico City Airport and his lacklustre Pemex strategy, which does little to address the long-term issues facing the state-owned oil company.

However, fears of a significant fiscal splurge have not materialised and state interventions implemented thus far have done little to derail the country’s sound fiscal health.

The latest economic data shows Mexican GDP unexpectedly contracted in the first quarter, falling -0.2% quarter on quarter, the worst start to a year in a decade.

This comes as private sector analysts have been cutting full-year growth forecasts for 2019. This decline in GDP is likely the result of budget cuts, layoffs in the public sector and a gas shortage crisis, although investor uncertainty surrounding Amlo’s appointment is likely to have contributed.

The real question is whether Amlo can stimulate long-term GDP growth to achieve his 4% target. While it remains too early to tell, there are some clear signs of growing investor confidence in the country.

Notably, Larry Fink (the head of BlackRock) is organising a joint investor conference this year and plans to partner with Mexico on a variety of infrastructure projects, including nationwide internet access and train links across the neglected southern regions.

Mexico is far from a riskless strategy. However, it seems the market’s preoccupation with Venezuelan-style socialist ruin may ignore the bigger picture, and this presents an exciting investment opportunity.

John Leiper is head of portfolio management, Tavistock Wealth.

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