Does Mexico Need More Reform for More Gains?

By Ben Levisohn

Mexico is at a turning point.

The countrys IPC stock index has gained 23% during the past 12-months, while the iShares MSCI Mexico Investable Market Index (EWW ) exchange-traded fund has returned nearly 30% including reinvested dividends and price appreciation.

Mexicos stocks have been boosted by the hope for reforms, some that have materializedlike changes to its labor marke tand others that are just hoped forsuch as ending government dominance of the oil and energy market .

How big a boost would loosening government control of the energy market give Mexicos economy? In a note today, Nomuras Benito Berber estimated that gross-domestic product growth could rise to 4.5% from the current 3%, depending on how far Mexico decides to take reforms.

The problem, however, is political in nature. Politically, interests linked to the powerful Pemex union in addition to strong nationalism have not allowed the changes in the Constitution needed to open up the energy sector, Berber says.

Despite the challenges, hes bullish on energy reform. Thats because President Enrique Peña Nieto campaigning on promises to boost the economy and boost oil production by allowing private investment in the sectorpromises he means to keep. As a result, his party is willing to negotiate to get the changes done.

Reform is no sure thing, however, Berber says. Already some proposals are being watered down and could be delayed until 2014.

If the reform process does continue, the value of Mexicos peso could increase, according to a separate report by Nomuras Tony Volpon which would only increase the returns for U.S. dollar investors.

But if reform peters out, so could Mexicos stock rally.

The iShares MSCI Mexico ETF has dropped 0.5% today, while its biggest holding America Movil (AMX ) has dropped 0.6%. Grupo Financiero Santander Mexico (BSMX ) has dropped 2.2% today to $16.33. The U.S. dollar has gained 0.6% against Mexicos peso, according to FactSet.

Dec 26, 2012

10:44 AM ET

Pimco Loves Mexicoand Other Old News Repackaged to Look New

On Mondays, Bloomberg releases something called a Greet the Week or Greets for short. These are essentially features touting an investment themeand during slow news weeks, can be a drag to put together, even when the advice is correct. Often, theyre cobbled together from older articles, which are used as evidence to support the broader theme. (I did my share during a six-month stint as an FX reporter at Bloomberg.)

Bloomberg

Thats a long winded introduction to Bloombergs Pimcos Gross Savors Free Lunch as Peso Bonds Beat Stocks. a greet  that hit on Monday.

While the headline makes it look like Bill Gross has something new to say, its actually old newsGross touted Mexico in a Dec. 13 interview on Bloomberg TV. And its Pimcos Michael Gomez, Pimcos co-head of emerging markets. who gets the quote: “With inflation well behaved, a strong government balance sheet, and steady growth prospects, Mexico has exhibited a sound macro policy mix, and has navigated well headwinds from the developed world, Bloomberg quotes him as saying.

The thesis, however, isnt a bad one. Emerging-market bonds denominated in U.S. dollarslike U.S. investment-grade and high-yield bondsare looking expensive. The iShares JPMorgan USD Emerging Markets Bond (EMB ) exchange-traded fund, for instance, has gained 17% this year, and has an SEC yield of just 3.3%, despite a duration of 7.65 years.  Thats two-and-a-half times the iShares Barclays 7-10 Year Treasury ETF (IEF ) 1.3% yield, but well below historical levels.

That has many strategists predicting that investors will have to turn to local-currency debt in 2013 to meet their yield needs.The Market Vectors Emerging Markets Local Currency Bond ETF (EMLC ), for instance, has an SEC yield of 4.9% and an average duration of 4.9 years, which makes it less susceptible to losses if interest rates rise.

Of course, local-currency bonds have currency risk, which tends to make them more volatile than their U.S. dollar denominated counterparts. But that might not be a bad thing to have in 2013, some strategists say. Many believe Mexicos peso, for instance, is undervalued and could rally even more this coming year.

That could make Mexicos bonds a good betif you can stomach the volatility.