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Will the Mexico ETF Shine in 2014?

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Mexican stocks had an excellent performance earlier this year as foreign investors poured money into the country on optimism over the election of President Nieto.

But like all emerging markets, Mexico also suffered the consequences of the "taper talk", though the pain in Mexican stocks and bonds was not as bad as some of the worst sufferers like Brazil, Indonesia and Turkey.

Mexican Peso has stayed remarkably resilient (almost unchanged YTD) while many currencies suffered double digit declines against the US dollar. (Read: Any hope for Brazil ETF in 2014?)

Is the Growth Picking Up?

The growth this year has been a meager 1.2% against most estimates of ~3.5% (worst since the 2009 recession). A number of external as well as internal factors including slower demand for Mexico’s exports and government spending delays were responsible for the slow growth.

The administration expects the growth to accelerate to ~4% in 2014. Many economists are optimistic about the economic recovery and expect a healthy rebound next year.

Foreign investors still seem to be optimistic on Mexico. The country saw investment inflows of $3.7 billion during the third quarter after the “taper” fears subsided. (See all Latin American ETFs Here)

Trade surplus grew in October, bolstered by the slow but steady economic growth in the US, the destination for 80% of Mexico’s exports, which account for about 25% of Mexico’s GDP.

Is President Nieto Delivering on His Promises?

President Nieto had promised to shake up the economy and he began by passing important education, telecom and fiscal reforms. A major energy reform is also likely to be passed soon as the government and the main opposition party have agreed on most of the crucial details of the legislative bill .

However the actual implementation of these reforms has not been easy for him. He has been facing opposition from vested interests. The delivery on promises made by him remains a “work in progress” though he seems committed and 2014 may be a crucial year for the country. (Read: Emerging Markets ETFs: How to Pick Winners?)

The energy bill has far reaching consequences for the Mexican economy as the country currently has very restrictive energy policies.  Giving the private-sector oil firms a far larger role in the Mexican oil industry, could attract billions of dollars of foreign investment into the country.

Mexico is currently the world's ninth-largest oil producer, but the country's oil production has fallen by 25% over the past decade to 2.5 million barrels a day,

Manufacturing Activity Continues to Surge

Many US companies, including hi-tech companies, are opening their manufacturing facilities in Mexico as wages in China and shipping costs continue to rise. Moreover, the goods coming from Mexico can enter the US duty-free due to NAFTA.

Mexico is now the world’s biggest producer of flatscreen TVs. It is also a leading supplier of automobiles, aircraft and medical equipment. Automobile production, mainly for exports has been surging.

Mexico is currently the fourth largest auto manufacturer in the world and is expected to be one of the top four by the end of this decade. The auto industry is likely to see an investment of $10 billion in the country. Energy reforms will further enhance Mexico’s competitiveness as a manufacturing destination.

Last year, Mexico’s manufactured exports were more than the rest of Latin America combined. Based on current trends, it is estimated that by 2018 America will import more from Mexico than from any other country. (Read: Best New ETFs of 2013)

Rising Middle Class and Soaring Consumption

As a result of macroeconomic stability, middle class wealth has been rising. Average income has doubled in the past 15 years and the average number of school years Mexicans attend has doubled in the past four decades.

Improving education and skills, and rising participation of women in the workforce has led to improving family incomes.

Rising family incomes and urbanization have resulted in upward mobility and increasing consumption. Per IMF, spending has grown from about 17% of GDP in 2000 to about 23% of GDP in 2012. Going forward, domestic consumption is expected to continue to fuel growth.

iShares MSCI Mexico Capped Investable Market Index Fund (EWW - Free Report)

Launched in March 1996, the fund now has more than $2.4 billion in AUM. The assets are invested in a basket of 51 holdings; America Movil occupies the top spot with almost 18% asset allocation.

Among sectors, Consumer Staples have the heaviest allocation (27%) while Financials and Telecom round out the top three. Thanks to its heavy exposure to consumer staples and telecom sectors, the fund will benefit from growing consumer demand in the country.

At the same time, there is a risk that the profitability of some of the giant operators in these areas will come down as the market opens up. Further, Mexico is not cheap; it trades at substantial premiums to its regional peers and other emerging markets.

However, the premium valuation for the ETF appears to be justified given the growth potential. In fact, this ETF now appears to be ready to rebound and has been outperforming the broader emerging markets ETF (EEM - Free Report) as well as the regional peer Brazil ETF (EWZ - Free Report) over the past few weeks.

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