As Hedge Funds Pile In, BlackRock Sees Risk in Mexico Election

(Bloomberg) -- Talk to most foreign investors about Mexico these days and you’ll likely to hear the same mantra: focus on Nafta now and worry about the upcoming presidential election later.

After all, the election isn’t until July and there’s growing optimism that Mexico will soon wrap up a revised trade deal with the U.S. and come away relatively unscathed. This month, hedge funds upped their bullish peso bets to the highest since September while overseas buyers are boosting investments in equities.

To BlackRock’s Jack Deino, it’s only part of the story.

Deino, the asset manager’s head of emerging-market corporate debt, says foreign investors are ignoring the very real possibility that Mexicans will elect populist firebrand Andres Manuel Lopez Obrador -- and underestimating the potential for asset price declines in the leadup to the vote. AMLO, as he’s known locally, has unsettled the nation’s political and financial elites and built a sizable lead in the polls in recent months. And he’s done it by railing against “neoliberalism” and corruption, and vowing to roll back efforts to open up the state-run oil industry.

“It’s a tale of two stories -- foreign investors are extremely benign and don’t see much risk related to the potential of an AMLO administration, meanwhile, their Mexican counterparts seem more concerned,” Deino said. “A lot of the risk isn’t priced in to valuations. There’s just a bullish tone on Nafta.”

In the past few days, some investors seem to have woken up to the likelihood that Lopez Obrador will become Mexico’s next president. The peso, which reached the strongest in more than six months against the dollar last week, has since slumped. The five-day selloff is now the worst since November 2016.

Poll Numbers

As recently as February, local business executives weren’t impressed by Lopez Obrador either. But now, it’s almost impossible for Mexicans to think about anything but the election, as ads blare on televisions and taxicab radios throughout the capital and Lopez Obrador maintains his lead at the polls.

The most recent surveys show 47.3 percent of potential voters prefer Lopez Obrador, far ahead of PAN-led party alliance candidate Ricardo Anaya, with 26.8 percent, and former Finance Minister Jose Antonio Meade of the ruling PRI party, who has 18.5 percent, according to Bloomberg’s Poll Tracker.

Yet among foreign investors, this fixation on the North American Free Trade Agreement -- and the possibility simmering trade tensions between Mexico and the Trump administration will be resolved by mid-May -- help to explain why Mexican markets have held up so well.

Since the U.S. trade representative suggested on March 29 that a deal could soon be reached, the currency and the stock market have outperformed all other emerging markets besides Colombia’s. Foreigners have also been boosting their holdings of Mexico’s government debt all month and hold 62 percent of the securities.

“The market should reflect everything and with what we know at the moment, nothing good for the market is coming out of the Mexico elections,” said Dirk Schnitker, the head of Latin American equity sales at Auerbach Grayson. But “the market tends to focus on only one thing at a time.”

Rising Populism

And in an age when the rising tide of populism has repeatedly caught the experts off guard -- from Trump’s election to the Brexit vote -- the seeming lack of regard over Lopez Obrador’s prospects is all the more surprising.

Some analysts, of course, have finally started to acknowledge that Lopez Obrador has a real chance at winning. But for most foreign investors, the election remains little more than an afterthought. That’s particularly true when it comes to the peso, says Jens Nordvig, founder of Exante Data and a former top-ranked currency strategist.

The peso has traded largely on changing Nafta probabilities and doesn’t “much swing on the signals from local politics,” he said, referring to his firm’s proprietary models. That’s underscored by the fact the peso has continued to rally, even as poll after poll in the past few months have consistently shown Lopez Obrador maintaining or widening his lead. Through last week, the peso was up 6.1 percent this year to 18.53 per dollar.

Nordvig sees the currency strengthening to 17.5 if negotiators reach a deal by May. (That’s 5.9 percent higher from where it is now.)

Traders are already positioning themselves for that outcome. Hedge funds and other large speculators held a net long position of 102,218 contracts as of the week ended April 10. That’s the most in seven months and up from a net long of roughly 35,000 at the start of the year.

Buy Now, Sell Later

It’s the same in the stock market, where overseas investors have been increasing their holdings at a faster pace than their Mexican counterparts since March, according to ETF data compiled by BlackRock.

“I’m bullish on Mexico because I am very bullish on Nafta,” said David Woo, Bank of America’s head of global rates, foreign exchange and EM fixed-income strategy and economics. While investors should “look to sell” after an agreement is reached, Woo said he expects the peso and local bonds to rally going into a deal.

Of course, it’s possible the bullishness in the market reflects the belief Lopez Obrador will moderate his more radical positions once in office. He recently met with business leaders to reassure them he’s not anti-business.

Kathryn Rooney Vera, the head of global macro research and emerging market strategy at Bulltick, says those who buy into that optimism are being naïve.

“There is so much complacency” with investors right now, she said. “It’s scary. When the market digs into what he is and what he previously proposed, including his current proposals, they are going to get spooked.”

There’s also the small, but ever-present risk that Donald Trump could throw a wrench in any trade deal negotiated by his own officials. On Monday, Trump tweeted that the U.S. may tie any new Nafta agreement to immigration from Mexico and border security.

Some investors have finally started to hedge their bets. According to Citigroup strategist Kenneth Lam, the peso’s reversal on April 19 -- when it fell almost 2 percent in the biggest retreat in over a year -- suggests “most of the good news has already been priced in” as the focus shifts to politics.

But like many others, Loomis Sayles’s Andrea DiCenso remains optimistic about Nafta -- at least for now. And as for Lopez Obrador?

“We’ll worry about that,” she said, “in another month’s time.”

©2018 Bloomberg L.P.

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