China has faced numerous setbacks post-COVID, paving the way for India to take the lead in driving emerging market (EM) economic growth. As a result, India could overtake China in equity benchmark weightings. Additionally, there’s been a significant tech capital expenditure boom, benefiting the likes of Taiwan. The wider AI value chain has also blossomed.
While these themes have dominated the headlines, it’s been easy to overlook developments in Latin America. Mexico and Brazil provide compelling and contrasting examples of countries that have plenty to offer discerning investors.
The US election – the return of the ‘Tariff King”
Donald Trump’s US election victory could have far-reaching consequences for EM. The US is Mexico’s neighbour and its largest trading partner. Mexico is understandably anxious about what comes next. A major challenge is the United States-Mexico-Canada Agreement (USMCA), which was set for review in 2026.
However, Trump’s victory has brought discussions forward. He’s already threatened to impose 25% tariffs on all goods out of Mexico. At the time of writing, this action had been postponed by one month. As a result, a deal could still prevail. Progress towards stricter border controls, tighter immigration rules, and measures to tackle drug trafficking could see Trump soften his stance.
Negotiations are not one-sided. US and Mexican supply chains have become increasingly entwined since the US-China trade war. Policies that significantly disrupt Mexico’s manufacturing sector will hurt US companies. That’s why, despite the rhetoric, we think the long-term impact of the trade spat will be more muted than feared. Indeed, most Mexican companies should absorb the fallout, assuming the key pillars of the trade agreement are preserved.
Conversely, Brazil is less likely to feel the sting from any potential tariffs. The country has gradually reduced its exposure to the US, which is no longer its largest trading partner. The impact of tariffs should be less harmful than in previous economic cycles.
There are indirect risks. Trump’s pro-growth economic policies will likely push up US inflation, meaning higher-for-longer interest rates and dollar strength. Unlike most EM countries, which have reduced rates, Brazil hiked rates in response to a deteriorating fiscal outlook that stoked inflationary pressures (currently 4.83% compared to the 3% target). This has been driven by robust economic activity and a tight labour market. The new central bank governor, Gabriel Galipolo, raised the rate by 100 basis points to 13.25% on 29 January in response and indicated more to come [1].
Galipolo faces a tricky balancing act. A cut in interest rates at some point would help support the economy, but this must be done under the right conditions to avoid questioning central bank independence. Weaker economic activity and a decline in President Lula`s popularity could lead the government to ramp up its leftist populist agenda. On the flip side, the adoption of a more pragmatic approach by the government could be a relief to markets. The next few months will be telling.
Political change
In a widely expected result, Mexico elected Claudia Sheinbaum as president on 2 June 2024. However, the strength of her party’s gains in the Senate and Congress surprised many, as did her approval of the controversial reforms laid out by outgoing President Andrés Manuel López Obrador. Sheinbaum was expected to dilute some of these proposals.
Investor sentiment dipped following the news. Since then, Sheinbaum has made overtures to the private sector, with many hoping this signals a more business-friendly, pragmatic approach to governing.
Brazil has delivered its own share of surprises. Moody’s recently upgraded the country’s debt, leaving it just one notch below investment grade. While unexpected by many, the decision points to a glass-half-full assessment of the economy. The ratings agency cited Brazil’s structural reforms since 2016, including social security, the labour market and a spending cap. Perhaps one of the most important reforms is the central bank’s independence.
Markets remain sceptical about the Lula’s new fiscal framework. The government could potentially meet this year's target, which seemed unlikely at the start of the year. However, while these reforms are welcome, they are short-term measures. The government must deliver long-term policies to address structural inefficiencies in public finances and foster a conducive environment for investment. This however, need to be balanced against the desire to act on its promises, including social welfare, healthcare, and education.
Listen to a recent podcast episode on Mexico
Outsized impacts
Brazil’s relationship with China is a risk and an opportunity. While Brazil has made good progress in diversifying its trading partners and may not rely on China in the same way as before, it remains a key market. This is particularly true for commodities, with commodity-related companies making up a third of Brazil’s benchmark index. Renewed optimism around China’s economic recovery, driven by increased stimulus, could support global commodity prices and provide a tailwind for Brazil’s economy.
In Mexico, nearshoring remains a key theme, despite peaking in the latter half of 2023. The industrial warehouse market – benefiting from traditional industries expanding to serve strong US demand – remains hot. Similarly, the flow of remittances into the country has helped to support consumption. Nevertheless, distinguishing between traditional trade-driven activity and new nearshoring demand prompted by supply chain shifts and geopolitics is crucial.
Currently, companies seem to be in a holding pattern, awaiting clarity on the USMCA renegotiation and potential tariff announcements. This uncertainty affects decision-making timelines, though the fundamentals for nearshoring to Mexico remain strong. Industrial real estate players in Mexico acknowledge challenges in attracting new clients in the short term. However, they remain optimistic about long-term demand if political and trade uncertainties are resolved without derailing the trend.
Innovation and opportunities
Domestic Mexican and Brazilian companies face challenges. Numerous companies are either defensive or are finding innovative ways to ride structural tailwinds. One such sector is fintech, which continues to disrupt traditional banking for both countries. A notable name to highlight is Brazil’s Nubank. While it’s rapidly expanding domestically, the largest opportunity could be in Mexico, according to the company, where credit card penetration is only 25% of the population. Another key player is Mercado Libre, the biggest online payment platform in Latin America.
However, all major traditional banks have established digital strategies to prepare for these new entrants. This process could help grow the overall size of the market, with innovative business models promoting financial inclusion and advancing overall banking penetration.
Listen to a recent podcast episode on Brazil
Final thoughts…
Mexico and Brazil have much in common. Their economies face short-term challenges and are likely to remain volatile. They also have differences that provide investors with a wealth of opportunity.
Brazil is a higher beta proposition given greater leverage in the economy and household finances making it more sensitive to interest rate changes. It is also more exposed to the fortunes of the Chinese economy Domestically, however, it lacks an obvious catalyst for growth, while fiscal discipline remains the pressing issue. The possibility of a political regime change or a policies becoming more pragmatic could be the turning point for Brazilian assets to rerate higher.
Mexico is perhaps the more intuitive investment option. There are numerous high-quality companies underpinned by structural drivers that are offering good earnings growth. That said, there are significant questions over the sustainability of its trade relationship with the US. Markets will also be gauging the impact of recently enacted policy changes on the medium-term economic outlook.
As investors, we feel it’s appropriate to have a foot in both camps. We favour a defensive tilt to investments and a focus on selecting bottom-up opportunities to take advantage of attractive valuations and potential volatility.