I just got back from a family vacation in Mexico to hear the news: President Trump is threatening to shutdown the U.S.–Mexico border if Mexico doesn't do something about Central and South American migrants travelling through on their way to the U.S.
Given the timing (April fools!) we might be forgiven for thinking the news was a joke. The news couldn't possibly be serious.
Although Washington has since softened its tone somewhat, President Trump continues to stick with his line of rhetoric, which leads us to examine our portfolio to see what impact the President's actions might have on our holdings.
A prolonged shutdown could have global implications
According to the U.S. Chamber of Commerce, trade between the U.S. and Mexico exceeds US$1.7 billion in goods daily—a long-term shutdown of the border would be a big deal for both U.S. and Mexican companies (likely worse for Mexico). It could result in reduced supply of goods produced and manufactured in Mexico, and much higher prices in the U.S. Although the likelihood is very low, an overall reduction in trade could also affect global economic growth.
One of our U.S. based, American equity managers, Barrow, Hanley, Mewhinney & Strauss, LLC (Barrow Hanley) confirms that we are not directly exposed to U.S.-Mexico trade. However, a border shutdown could indirectly pressure labour and wages for some U.S. industrial holdings. They go on to say that the impact should be marginal at best.
A sentiment-driven sell-off of the Mexican Peso is another possibility, which could result in greater inflation in the Mexican economy. Again it would seem unlikely that U.S. policy would drive such a sustained depreciation, unless the administration moves to cut off remittances from the U.S. to Mexico, which also seems unlikely. Mexico's interest rates could also move higher which, if sustained, could decelerate economic growth (Real interest rates in Mexico are already very high).
In reality though, Barrow Hanley says failure to ratify the U.S. Mexico Canada Agreement (USMCA) or economic mismanagement by the Mexico's administration are two scenarios that would be far more damaging than any short-term border closure.
Speaking with our investment management partners at Comgest S.A., they say Mexico's real worries are being driven domestically: Among other things, the country's President, Andrés Manuel López Obrador is also flirting with populism which tends to make investors run away.
Looking for diversified profit streams and predictable cash flow
From a portfolio perspective, we are well positioned to weather a U.S.-Mexico border shutdown or slowdown if it does come to pass. Clients typically have approximately 5% of their portfolios allocated to the MDPIM Emerging Markets Equity Pool, of which approximately 3% is invested in Mexican-domiciled companies.
The majority of this Mexican exposure is invested in two companies. The first is Fomento Económico Mexicano, S.A.B. de C.V. (FEMSA), a multi-national beverage and retail company which bottles Coca-Cola and operates one of the largest convenience store chains in Mexico. The second is Infraestructura Energetica Nova SAB de CV (IE Nova), a natural gas distribution company.
Comgest says the reality is that the two economies—the U.S. and Mexico—are very integrated, which means a border shutdown will have unpredictable consequences. Independent of any real impact, investor sentiment and country risk perception would also be affected if the border were closed totally, partially, or just closed to human traffic.
In this context, our investments in FEMSA and IE Nova are quite defensive. In the first case, more than one-third of FEMSA's profits come from abroad. Domestically the company is a basic consumption, almost consumer staple play. In the second case, IE Nova, has very visible cash flows, thanks to established, long-term U.S. dollar contracts. Share price does react to short-term market fluctuations driven by perceived risk, but company fundamentals remain solid.
Both companies would be affected if Mexico's economy slows but the impact we expect from a border closure is likely to be minimal.
Hands off my avocado!
Where would a border closure likely be felt the most then? At the grocery store. Mexico is known for its production of car parts and some electronic products, but produce prices are likely where Canadians will feel the most immediate pinch.
Whether President Trump can legitimately close the border, or simply put measures in place to slow the flow of goods and services, there will be increased costs for consumers, no matter how you slice it.
The big issue for investors meanwhile, is whether or not a border shutdown would materially impact company earnings in the long term. In truth, I don't believe there is a big risk for MD investors. I believe that any pain we'll feel through this will be short-lived. To the extent that we do have companies depending on trade with Mexico, I expect the challenge will be passed along to consumers. Companies will likely solve the problem by increasing prices on the produce they are able to get, and consumers in turn, will likely need to make different purchasing decisions about which fruits and vegetables they're going to eat. We may need to rethink our love for avocados.
If you have any questions about how the U.S.-Mexico relationships might affect your portfolio, please contact your MD Advisor1.
1MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.