Wealthy Nations Daily Update - the Australian Drop Bear and Mexican Toro

Australian and Mexican equity and bond sentiments seem to suggest contrasting regional opinions.

If you visit Down-Under the locals may try to frighten you into believing in the ‘drop bear’ - a ferocious predatory koala that drops from above onto unsuspecting prey, be they a wombat or an expat. If you’re gullible you might follow their instructions to smear vegemite on your earlobes or urinate on your clothes to keep them at bay... The drop bear may be a hoax but Australians have a different sort of bear to be concerned about. Today’s headlines suggest that Australian stocks officially entered bear market territory, with the ASX200 at 4775, down over 20% from previous highs of 5997 in March 2015 (In fact they are down over 30% from 2007 highs so technically they haven’t stopped being in bearish territory for the best part of a decade). They join the growing club of global stock indices that are in bearish territory in terms of both 52-week highs and all-time highs including respectively: Euro Stoxx 50 (-27% / -46% Mar’00), French CAC (-22% / -36% Jun’00), German DAX (-27% Apr’15), Italy MIB (-31% / -66% Feb’00), Spain IBEX (-31% / -46% Dec’07), Brazil Ibovespa (-34% / -42% Mar’00), Hang Seng (-32% / -31% Dec’07) and of course Japan Nikkei (-25% / still down -60% from December 1989).

In total 12 of the 18 indices on Bloomberg’s World Economic Indicator (WEI) screen are now well into bearish levels. The one to watch for future media hype will be the UK FTSE 100 which currently down 19.8% versus highs from last April; it may not take much for this hurdle to trip up wider market sentiment.  Contrastingly the S and P 500, DJIA and Mexican Bolsa, for the time being, seem to be safe from technical bearish territory - ‘only’ being down -13%, -12.6% and -8.5% respectively from recent all-time highs. That last one might come as a surprise. That the Mexican Bolsa IPC Index has been the most resilient of these major indices is not what you might infer from headlines, ratings or relative bond yields.

It’s perhaps worth a cursory contrasting of these austral and boreal commodity rich nations, Australia and Mexico, to see if the equity markets have judged them right or if the inverse sentiments within the bond market are justified. AAA rated Australian 10yr yields have shifted from 3.2% to 2.4% since mid-2015 compared to a Mexican risk-off period (correlated with other LatAm countries) taking 10yr yields from 3.8% to 4.2%.

First take exports partners; Australia’s largest export partners are China ($95bn), Japan ($45bn) and Korea ($20bn) whereas Mexico’s are US ($270bn), Canada ($24bn) and China ($8bn). Clearly Mexico is intertwined much more with the US economy than most people assume and more than other LatAm countries whereas Australia is fastened to China’s slowing growth and shift away from recent commodity gorging. Second export industries; Australia exports primarily consist of iron (26%), coal (16%), gold (8%) and gas (6%) compared to Mexico vehicles and parts (21%), crude (11%) with its largest export sector actually being machinery and technology (around 34% in total comprising 5% computers, 5% video displays, 3% telephones…). Third Net Foreign Asset (NFA) analysis of the two countries places Mexico as 3 star making it a net debtor but at sustainable levels of less than 50% of GDP. Australia, seemingly disparate from its AAA rating, is only 2 star with net foreign debts approaching 100% of GDP - a level at which our models and historical analysis suggest is unsustainable and poses a significant vulnerability.

At least on these basic terms it seems equity indices are better accounting for the respective risks in both these countries. Australian debt thus seems expensive and overrated whereas Mexico is potentially undervalued and more robust than most would give it credit. Such preexistent value should act as a cushion in times of risk-off in addition to the underestimated underlying ability to pay. Quasi sovereign issuance can offer even more value and can complement a portfolio that has a higher overall credit quality.