Oh, Mexico

Oh, Mexico, I’ve never really been but I’d sure like to go
Sing, whoa, Mexico, I guess I’ll have to go now

–James Taylor, “Mexico”

The presidential election is just about six months from now, but so far in 2024, investors have largely ignored politics. I suspect that will gradually begin to change in June with the presidential debate, and as the two candidates come more into investor focus, we can expect lengthy discussions of the policy implications for markets. Most of the policies between the two candidates are starkly different. But one area they are in agreement on is being tough on trade with China.

In this morning’s issue of the Eagle Eye Opener, my “secret market insider” and I explored the issue of China policy and how that may have filtered down to concerns about the emerging markets more broadly. And as you are about to read, there is one emerging market that usually flies under the radar that’s in good standing in trade terms with the United States, and that has outperformed and could be the beneficiary of U.S. companies diversifying away from China and other Asian countries.

That beneficiary is Mexico.

When most investors think of emerging markets, countries such as China, Taiwan, India and Korea are top of mind. That makes sense, as these countries account for over 70% of emerging market indices. But Mexico is just 2.7% in the MSCI EM Index, and we think it stands to benefit from the ongoing trends of “friendshoring” and “nearshoring.”

Friendshoring is a deliberate policy decision to encourage trade with friendly neighbors at a time when geopolitical tensions are high. The U.S.-Mexico economic partnership has strengthened due to Covid-19 and the United States-Mexico-Canada Agreement (USMCA, formerly NAFTA), which offers mostly duty-free trade zones.

Nearshoring is the practice of outsourcing a service to a third-party provider in a nearby country. This is obvious with Mexico’s close proximity to the United States and a nearly 2,000-mile U.S.-Mexico border. Goods from Mexico can often reach their U.S. destinations in a day or two by truck or rail. (Additionally, Mexico has sea access to Asian and European export markets via the Pacific Ocean and Gulf of Mexico, providing another way for foreign goods to get to the United States. And Mexico has free trade agreements with roughly 50 other countries).

In fact, Mexico became the No. 1 trade partner of the United States in 2023. It took the spot from China, which was the leader for about a decade. Mexico offers numerous advantages that should allow the continued diversification of global supply chains by multinational companies (nicknamed “China plus one”) to make a sustained impact in the years ahead.

Advantages include a skilled and young labor force, cheaper labor, government incentives (discounts, grants, training, tax incentives, etc.), solid infrastructure in the north and easy access to the United States (beneficial to foreign countries, too). Some manufacturers estimate up to 25% production cost savings in Mexico versus equivalent U.S. facilities, and hundreds of U.S. companies are taking advantage.

Here’s a sampling of large U.S. companies with headquarters, R&D, operations, outsourcing and/or investments in Mexico: Ford, Procter & Gamble, American Express, GM, Microsoft, John Deere, Amazon, FedEx, AT&T, Meta Platforms, Coca-Cola, McDonald’s, Walmart, Pfizer, IBM, Exxon Mobil, General Mills and Nike. Notice the diversification, with companies from many sectors and industries.

As Bradford Freer, portfolio manager of the New World Fund, said regarding a recent visit to Mexico, “I was shocked to see the magnitude of what’s happening. It reminded me of the cities I visited in China during the 1990s and early 2000s, with these bustling multi-million square foot facilities and thousands of workers building at scale. That’s now happening in northern Mexico at a rate I think is surprising to a lot of people.”

Beyond the friendshoring and nearshoring catalysts, Mexico has other solid growth and value characteristics in play. The country has momentum, as the MSCI Mexico Index was up 41.5% in 2023, strongly outperforming the S&P 500 Index’s 26.3%. (Mexico also outperformed 19 of the other 23 emerging market countries last year.) The iShares MSCI Mexico ETF (EWW) has a 2.4% dividend yield, which is double SPY’s 1.2%. And it’s considerably cheaper in terms of price-to-earnings (P/E) ratio, 11.4 (EWW) versus 22 (SPY).

That’s not to say there aren’t risks, which include: 1) Mexico’s electricity grid needs to be strengthened, 2) Southern Mexico is underdeveloped compared to northern Mexico, 3) Corruption, 4) Presidential elections are coming for both Mexico (early June) and the United States (early November) in 2024 and 5) U.S. recession (the biggest risk).

For investors, there are three good Mexico exchange-traded funds (ETFs) to choose from: iShares MSCI Mexico ETF (EWW), Franklin FTSE Mexico ETF (FLMX) and Direxion Daily MSCI Mexico Bull 3X Shares ETF (MEXX). EWW is likely the best option if you’re inclined to make a direct bet. It has the highest assets under management (AUM) ($2.1 billion), most liquidity (trades two million shares per day) and longest history (1996 inception).

FLMX is the least costly option (0.19% expense ratio). And MEXX, although very risky with its leverage, provides the most bang for your buck. EWW also has a 0% weight in the technology sector. So, if you’re overweight technology, it can serve as an offset.

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ETF Talk: Finding Heavenly Returns in a Fallen Angel

You don’t need me to tell you that we live in an uncertain world. The war between Russia and Ukraine is continuing to rage, as is the conflict between Israel and Hamas. As the effects of both conflicts have long since percolated beyond their respective countries’ borders, more than a few investors are turning to less-well-known investment strategies in order to protect their hard-earned capital.

One of these investment strategies involves the trading of so-called “fallen angel bonds,” and it behooves us to talk a little bit about what they are before diving into this week’s exchange-traded fund (ETF).

Two kinds of bonds concern us here — investment-grade and high-yield bonds. Investment-grade bonds are rated the best and are the most probable to give you your money back if you hold them to maturity. High-yield bonds have higher interest rates but are riskier to hold (as indicated by their lower credit ratings) and have a higher chance of default.

Now, a bond’s credit rating isn’t fixed like a star in a constellation. It can change based on the economic status of the issuer. When an investment-grade bond falls from grace and becomes a high-yield bond as a result of a credit downgrade, we refer to it as a fallen angel bond.

But why invest in them?

That’s a good question, and one of the main reasons for doing so is for diversification. A 2024 study by Bloomberg showed that, when comparing the Bloomberg US HY Fallen Angel 3% bond index and the Bloomberg US Corporate High Yield Index to the S&P 500 Total Return Index over 10 years, investing researchers found that there was a lower correlation between fallen angels and equities than high-yield bonds and equities. A report by BlackRock also noted that, over the long term, fallen angels as a whole have outperformed the broader investment-grade and high-yield bond markets, only underperforming in part of 2016 and part of 2020.

Of course, as always, past performance is not a guarantee of future performance.

One exchange-traded fund (ETF) dedicated to fallen angel bonds is the VanEck Fallen Angel High Yield Bond ETF (NASDAQ: ANGL). It focuses on below investment-grade corporate bonds denominated in dollars, issued in the United States and that were rated investment-grade at the time of issuance. ANGL seeks to replicate the ICE US Fallen Angel High Yield 10% Constrained Index.

Some of the firms whose bonds are in ANGL’s portfolio include Vodafone Group Plc (NASDAQ: VOD), Newell Brands Inc. (NASDAQ: NWL), Entegris Inc. (NASDAQ: ENTG), Walgreens Boots Alliance Inc. (NASDAQ: WBA), Dresdner Funding Trust I, Telecom Italia Capital Sa (OTCMKTS: TIIAY), Resorts World Las Vegas Llc, Eqm Midstream Partners and Nordstrom Inc. (NYSE: JWN).

As of May 28, ANGL has been up 1.10% over the past month and 0.84% for the past three months. It is currently up 0.99% year to date.

Chart courtesy of www.stockcharts.com

The fund has amassed $3.07 billion in assets under management and has an expense ratio of 0.25%.

Overall, the ANGL ETF may be a good choice for investors looking for exposure to the fallen angel bond sector, but it’s important to carefully consider the risks and potential returns before making any investment decisions.

As always, I am happy to answer any of your questions about ETFs, so do not hesitate to send me an email. You just may see your question answered in a future ETF Talk.

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In case you missed it…

More Ugly ‘Tearing of the Flesh’

Well, it happened again. Last weekend, I witnessed more of the ugly personality trait that I find subversively vexing, caustic and very revealing. That behavior is sarcasm, and it’s a hostile trait that should be avoided in others and in ourselves. The presence of sarcasm, especially between life partners, is especially irritating to me, as it leads to nothing good.

I say this because contrary to popular belief, sarcasm isn’t just witty humor, or a sign of intelligence or mere kidding around at another’s expense. I am not referring here to good-natured jocularity. Rather, I am referring to the actual nature of sarcasm, which is a form of hostility toward others and to oneself that’s merely disguised as humor.

I explored my feelings about this issue about eight months ago in The Deep Woods, but I feel so strongly about its pernicious social and personal effect I have decided here to tell you all about it once again, as the example I witnessed this weekend (details shall remain unrevealed to protect the guilty) brought my original thoughts to the front of mind.

To understand my antipathy to sarcasm, we must first better understand the origin of the word. You see, sarcasm is derived from Greek words that mean “tearing of the flesh.” So, when we describe someone as having a “biting” sense of humor, it refers to the “tearing of the flesh” that takes place when someone wants to hurt another person.

Let’s take a look at this in terms of a real-world example. Now, this example comes directly from a friend of mine, and I was granted his permission to use it for this article. Here’s what took place between husband and wife.

The couple was about to go to Disneyland, and the wife asked if the husband knew the right roads to take. The man said he did, as he remembered the route from the last time he was there.

After a few wrong turns and some confusing road restrictions due to construction, the couple found themselves off track and somewhat lost. The husband then said, “I thought I knew the right way, but somewhere we made a wrong turn.” The wife, and here is the sarcasm part, then said in a mocking tone, “Wow, I always knew you had a great sense of direction.”

Now, at first glance, you may not think this is a big deal. But it is a big deal, and I will tell you why.

The husband had admitted that he was wrong about the route and made a mistake (a quite common one at that). Yet, rather than try to help the situation by using the GPS on her phone to help navigate a new route or to tell him that it was going to be ok, the wife took the opportunity to tear at the flesh by insulting the man’s acumen at navigating life.

I wonder how many other not-so-subtle sarcastic remarks this woman has made to this man over the years, remarks that have eroded their love and friendship little by little, like a leaky pipe that allows water to slowly seep into the walls, building up mold until the levels become toxic. Indeed, the fact that my friend told me about this episode when I asked him how things were going tells you right there that this is not just some harmless form of kidding.

Yet for those who wear their sarcasm as a badge of honor, or who hoist their sarcasm flag up the pole as some sort of virtue to the world, they can always just hide behind the bromide, “I was only kidding” when they’re challenged on their behavior.

Most of the time, however, the sarcastic person claiming they were only kidding is the one who is kidding themselves. The truth is that kidding with the intent to tear the flesh is hurtful, petty, cowardly and passive aggressive. I say “cowardly,” because if the sarcastic person had any guts, they would just come right out and tell the other person what they think is the problem.

To this I say, don’t abide sarcasm — not in others, and especially not in yourself.

Like nearly everyone, I have been guilty of this fault many times. Yet, every time I’ve reflected on my bouts of sarcasm, I’ve become a little less valorous in my own eyes.

If, after your own reflection, you find that your personality tends toward sarcasm, ask yourself why. What are you trying to convey to others or the world? If you are trying to show the world you have an intelligent sense of humor, then perhaps you can do so in another fashion, one that is humorous but one that isn’t carried out by tearing at another’s flesh.

Of course, if you just want the world to think you are a witty jerk, then that’s probably what the world thinks of you anyway. And hey, good luck with that.

Finally, remember that sarcasm is intended to be a little dig on another. And when it comes to relationships, repeated little digs will inevitably become big holes.

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The Pleasure Principle

“What we learn with pleasure we never forget.”

–Alfred Mercier

For a rational man, pleasure is a result of the achievement of values. It’s the result of confirmation in your mind’s ability to grasp, unpack and mold reality. I find that learning is one of the most pleasurable pursuits I can engage in. Yes, learning new skills can be strenuous and frustrating at times. Yet when that strain and frustration results in the discovery of something new or a newly acquired skill, well, there can be no pleasure greater than that.

Wisdom about money, investing and life can be found anywhere. If you have a good quote that you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.

In the name of the best within us,

Jim Woods