The Daily Update - Mexico Pemex

As the US election runs its course, Mexico has been caught in the cross winds with short sellers prevalent in stock ETF’s and the Mexican peso being sold-off aggressively. Hedge funds are also very active in the credit-default insurance market taking out protection on Mexican bonds.

The reason for this is concerns over the future of the North American Free Trade Agreement (NAFTA) as both Trump and Clinton have made statements which throws the agreement into unknown territory. Trump openly wants to seize remittances, increase deportations and leave NAFTA, while Clinton has described the agreement which has been in place from 1994 as “a mistake”.

Why is Mexico the target you might ask? Broadly Mexico exported $322bn in goods and services to the US and Canada last year, almost seven times more than the next 13 largest trading partners combined and hedge funds are positioning themselves to take advantage of a Trump presidency. One of our contacts advised us; tongue in cheek, to buy shares in CEMEX, the Mexican cement producer as the only hedge against Trump and his intended wall between the two countries.

Mexico remains a three star country under our Net Foreign Asset scoring system, although we do forecast a weakening in their scoring over the coming three years due to a reduction in oil revenue and a growing current account deficit. The economy at $1.1tn has grown since 2013 but some weakness is expected over the coming period.

However, the bonds issued by the likes of Petroleos Mexicanos (Pemex) the state owned Integrated Oils company rated BBB+ by both S and P and Fitch does appear to be pricing in the risks. The Pemex 5.5% bonds maturing in 2044 are priced at 90.20 and yield 6.25% which is a spread of 405bps over Treasuries, we see “fair value” at around 211bps and so this bond trades over 4 credit notches cheap inferring a move up in price of 29 points to reach its fair value.

As risk managers we have to calculate if we are getting paid adequately to take on risk even though the future may not be, at the moment, as rosy as we would like in some investments, but then again would you get paid as much if the outlook was more secure. A four notch credit cushion does appear to be decent pricing for Pemex but it is a name we have constantly under the microscope.

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