Is Mexico going over the Fiscal Cliff?

With little more than a week before the United States presidential election campaign concludes many of the US’s trading partners are anxious to learn of the country’s fate in light of the looming fiscal cliff.  Three and a half years into a recovery from the greatest financial calamity since the great depression the more US co-dependent emerging markets are hanging by their fingers as well.

Image courtesy Jeinny Solis S.:http://www.everystockphoto.com/photographer.php?photographer_id=48577

Mexico City skyline, with the tallest building to the left the Torre PEMEX, the second tallest building in the city. The triangular building is the Mexican Stock Market.

America’s neighbor to the south, Mexico, is perhaps the most immediately affected by United States but it has also been one of the better performing emerging markets of recent years.  Cited last week in Foreign Policy online as one of the five best performing emerging markets the outlook for 2013 is questionable and heavily influenced by what happens in the US.

If the US fails to effectively address the fiscal cliff the Mexican economy is likely to be one of the first casualties.  This year, however, Mexico is expected to grow in the range of 3.5-4% and is targeting 3.5% next year according to government forecasts. 

In an number of ways Mexico has been working to protect itself from negative external influences: in terms of fiscal consolidation, public debt management and catastrophic risk assurance.  Mexican markets have been assuming that the US was going to address the fiscal cliff gradually not with what may prove to be an abrupt resolution.  Public debt management has been a source of strength in Mexico as opposed to is being witnessed in Europe and to what has been witnessed in Mexico in the past.  

And while the Mexican central bank is considering raising rates due to inflation this may change quickly with a reversal of economic fortune thanks to the US mishandling the Fiscal Cliff.  A most likely scenario is that a falling US economy will drag the Mexican economy down with it.  And a falling US economy, and US stock market, will likewise erase gains in Mexican equities.  The three year chart below shows the gains the iShares Mexico Investable Market Index (EWW, quote) has made recently.

Unfortunately that success has come with tightening of the correlation between EWW, my proxy for Mexican equities, and the SPDR S&P 500 Index Trust ETF (SPY, quote), my proxy for US equities. 

Finally the 12 month chart exhibits more of the same.  Both ETFs and their respective indexes have performed well since the market bottom in March 2009 and during the recovery in the US economy.

However, as the “Cliff” approaches and as many question the ability (or desire) for either political party to address it properly the outlook for 2013 in the US has dimmed.  Some still forecast higher stock levels overall but many do not.

For investors in Mexican equities it will likely be the Macro-view that matters most.  A recession in the US and declining stock markets will impact Mexico directly and in sympathetic fashion.  For the time being anyway investors must look to the US for the future direction of Mexican stocks.