CIO REPORTS
The Weekly Letter
MAY 9, 2017
Chief Investment Office
Mexico: the Global Piñata: Like a piñata, Mexico’s economy contains many long-term goodies. Rodrigo C. Serrano
Among them are a demographic dividend, ample room for greater use of credit and the passage of Vice President
an ambitious reform agenda. Escalating trade tensions with the U.S. and other developments raise Joseph P. Quinlan
the risk of shattering this piñata, with some of the rewards from structural reform and favorable Head of Market &
Thematic Strategy
demographics falling by the wayside.
Markets in Review: Last week equities were mostly higher, with the S&P 500 appreciating
Recent Publications
0.7% and international equities, as represented by the MSCI EAFE Index, rising strongly by 1.8%.
Weekly Letter
Meanwhile bond prices fell, with the 10-year Treasury yield up 7 basis points to 2.35% from 2.28%
Retailers’ demise greatly
on Friday of the prior week. Commodities overall, as measured by the Bloomberg Commodity exaggerated
Index, declined 1.6%, with WTI crude leading the way with a 6.3% plunge to $46.22 per barrel. Gold Policy Prognostications
moved lower, falling 3.7% to $1,221.60 per ounce. Profits Powering On
Bonds still matter
Looking Ahead: In the U.S., investors will digest gauges of small business confidence and Monthly Letter
consumer inflation. Notable regarding the former would be how political developments in International vs. U.S. Markets —
Washington are affecting “animal spirits” in the economy. In the Eurozone, industrial The Tide Could Be Turning
production highlights a relatively light week of aggregate economic data for the bloc. ISC Viewpoint
Charge: Synchronization Intact
Mexico: the Exhibit 1: Mexico has been a star reformer
Global Piñata
% of OECD Reform Recommendations
60
With Significant Action Taken
50
Like a piñata, Mexico’s economy contains many
40
long-term goodies. Among them are a demographic
30
dividend, ample room for greater use of credit and
the passage of an ambitious reform agenda. Escalating trade 20
tensions with the U.S. raise the risk of shattering this piñata, 10
with some of the rewards falling by the wayside. A 6.5% 0
G7 OECD EU *Peer **Southern Mexico
depreciation of the peso between the U.S. presidential election OECD Europe
and March 10th serves notice of the potential damage.
Source: GWIM Chief Investment Office; OECD, “Going for Growth,” 2015.
*Peer OECD countries include Chile, Estonia, Hungary, Mexico, Poland and Turkey.
Positioned to grow in a globalized world ** Southern Europe countries are Greece, Italy, Portugal, and Spain.
Mexico’s demographic dividend is the result of a prolonged
and ongoing surge in the proportion of working-age adults Recent financial reforms were aimed at increasing inclusion
relative to non-working dependents. The median age of the in financial markets by expanding access to credit for small
country’s population is 28, nearly 10 years below that of the and medium businesses and households. In a 2014 report
U.S. What’s more, female participation in the workforce published by the World Bank, Mexico had a mere 39% of its
is very low, at 47%, versus the Organisation for Economic population with an account at a financial institution, compared
Co-operation and Development (OECD) average of 63% as of to the Latin American average of 51% and the U.S. at 94%.
2015. Finally, reducing the nation’s informal labor sector,
Mexico’s energy reform, enacted in 2013, is viewed by many
constituting just over 57% of total employment, according to
as the country’s most important in scope. By liberalizing
the OECD, is another potential growth generator.
the nation’s energy sector, the reform aims to address a
When it comes to reforms, Mexico has far outperformed protracted decline in oil production, aging infrastructure and
the G7, European Union and peer OECD members in taking limited technological development. Despite weak oil prices,
significant action towards the OECD’s recommendations, successful auctions have sown the seeds for sustained
according to its 2015 report Going for Growth (Exhibit 1). investment in the country and a brighter future.
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Other reforms focus on expanding the tax base, reducing U.S.-Mexico trade is done between American multinational
dependency on oil revenues, opening up the telecommunications corporations and their foreign affiliates. In addition, without tariff-
and broadcasting sectors to foreign investment, enhancing free access to the wealthy U.S. market, other countries with large
the rule of law and reducing corruption, which would improve operations in Mexico may consider cutting back investment.
regulatory credibility and increase investor confidence.
Meanwhile, rising interest rates could increase the prospect of
Mexico’s increased integration into the global economy recession, raise the likelihood of a serious challenge by an anti-
has also proved a catalyst for growth. The country has signed establishment party in Mexico’s 2018 presidential election and
12 free-trade agreements encompassing 46 countries. It is call into question Mexico’s commitment to implementation of its
a participant in nine economic cooperation agreements panoply of reforms. Such a prospect would weigh on the country’s
and maintains 32 accords promoting reciprocal investment investments, where foreigners own 35% of local-currency
promotion and protection. Such connections have transformed government bonds, the highest among Emerging Markets.
Mexico into a diversified manufacturing base, with total trade In addition, the stock of foreign portfolio investment clocks at
comprising over 70% of its gross domestic product (GDP), 40% of GDP, according to the International Monetary Fund.
and a dominant player in the global automotive industry.
For the U.S., the risks, while not equally threatening, are
A broken piñata would be painful significant. In 2015, Mexico was its second-largest goods export
Rising trade tensions between Mexico and the U.S. and market. With its highly developed maquiladora sector, Mexico is
other developments have clouded the outlook. For Mexico, a pivotal partner for the production of automobiles. According to
the peso’s selloff and an ill-timed 20% hike in gasoline prices, the Center for Automotive Research in January 2017, U.S. content
known locally as the gasolinazo, have led to increased social of vehicles imported from Mexico to the U.S. is 40%, up from 5%
unrest. Banxico, the country’s central bank, has hiked its policy before NAFTA was signed. Furthermore, comments made by the
interest rate seven times since late 2015 to 6.25% to defend Mexican Minister of Economics suggest a mirroring by Mexico
the peso and lean back on rising inflation expectations. of protectionist measures taken by the U.S. Moreover, the global
community would take notice, given a possible violation of World
Meanwhile, President Peña Nieto’s approval rating remains
Trade Organization rules. Worsening conditions in Mexico may
near the lowest level for any president since 1995, according
ironically reignite illegal immigration, increasing tensions.
to Bank of America Merrill Lynch (BofAML) Global Research.
He is criticized for corruption allegations and failing to stop Battered but not broken
mounting crime, while his reforms have failed to produce the Fortunately this is not our base case. Mexico’s economy has
robust economic growth promised at the start of his term. remained resilient, given advanced implementation of various
reforms. Furthermore, a weakening peso has not been all bad; U.S.
Exhibit 2: U.S. and Mexico — Strong Links dollar remittances to Mexico have buoyed consumption. Although
U.S. Industrial Production Mexico Industrial Production BofAML Global Research expects real GDP growth to slow
15 this year to 1.25%, the peso should continue to act as a shock
absorber, shifting consumption towards local goods and services.
Year -Over-Year Change, (%)
10
5
However, a clouded U.S. policy outlook and uncertainty
0
surrounding the 2018 Mexican elections should eventually
-5
reduce domestic and foreign investment. The balance of risks
-10
is skewed to the downside. BofAML Global Research expects
-15
NAFTA to be adjusted marginally, but with negative headlines
-20
for months to come. While it is not expected that the border-
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
adjustment tax (BAT) will pass in its current form, if at all, this
Source: National Institute of Statistics and Geography (Mexico) and Federal Reserve. policy is where the risk for global trade lies.
As of December 31, 2016.
The latest developments between the U.S. and Mexico are being
In the medium to longer term, both Mexico and the U.S. face closely scrutinized worldwide. As one of the targets of Trump’s
risks. For Mexico, its intricate connection with the U.S. — with “America First” policy, Mexico can be seen as a canary in the coal
over 80% of its exports northbound and a remarkable mine, an indicator of how the president’s proposals are translated
correlation between the growth of the two nations’ industrial into action. If the more extreme departures from current policies
sectors — exposes the double-edged sword of economic are enacted, global sentiment may shift negatively, leading to a
openness (Exhibit 2). Fears of continuing trade tensions risk pause in investment decisions worldwide, and a diminution of the
stalling investment this year, as a considerable portion of current global cyclical recovery.
CIO REPORTS • The Weekly Letter 2
Markets in Review
Trailing Economic Releases Equities
Total Return in USD (%)
The Federal Open Market Committee did not send any notable signal
Level WTD MTD YTD
on the future path of interest rate hikes, suggesting that the recent
DJIA 21,006.9 0.3 0.3 7.1
disappointing economic data in the U.S. were transitory. Investors
NASDAQ 6,100.8 0.9 0.9 13.7
look to June as a “live” meeting, should economic data rebound in the S&P 500 2,399.3 0.7 0.7 7.9
second quarter as expected. S&P 400 Mid Cap 1,738.5 0.4 0.4 5.2
The U.S. Bureau of Labor Statistics reported that 211,000 jobs Russell 2000 1,397.0 -0.2 -0.2 3.4
were created in April, above the BofAML Global Research estimate MSCI World 1,896.8 1.0 1.0 9.1
of 170,000 and March’s reading of 79,000. Meanwhile, the MSCI EAFE 1,864.9 1.8 1.8 12.0
MSCI Emerging Mkts 978.3 0.1 0.1 14.0
unemployment rate fell to the lowest level in nearly a decade at
4.4%. The result bolsters the claim that the recent slowdown in Fixed Income
U.S. economic growth is transitory. Total Return in USD (%)
In the Eurozone, Eurostat reported seasonally-adjusted, quarter- Yield (%) WTD MTD YTD
over-quarter growth of 0.5% for real gross domestic product (GDP) ML US Broad Market 2.54 -0.2 -0.2 1.4
during the first quarter. Given a better than expected result versus ML 10-Year US Treasury 2.35 -0.5 -0.5 1.6
its estimate, BofAML Global Research raised its full-year 2017 GDP ML US Muni Master 2.41 0.0 0.0 2.1
forecast to 1.7% from 1.5%. ML US IG Corp Master 3.30 -0.2 -0.2 2.2
ML US HY Corp Master 5.77 -0.1 -0.1 3.7
S&P 500 Sector Returns (as of last Friday’s market close)
Commodities & Currencies
S&P 500 Sector Total Returns (week-to-date)
Total Return in USD (%)
Information Technology 1.4% Level WTD MTD YTD
Financials 1.3%
Bloomberg Commodity 167.5 -1.6 -1.6 -5.3
Industrials 0.9%
Materials 0.7% WTI Crude $/Barrel1 46.2 -6.3 -6.3 -14.0
Healthcare 0.6% Gold Spot $/Ounce1 1,221.6 -3.7 -3.7 6.0
Real Estate 0.4%
Prior Prior 2016
Utilities 0.1%
Level Current Week End Month End Year End
Consumer Discretionary 0.1%
Consumer Staples 0.1% EUR/USD 1.10 1.09 1.09 1.05
Energy -0.7% USD/JPY 112.71 111.49 111.49 116.96
Telecom -1.2%
Source: Bloomberg.1 Spot price returns. All data as of last Friday’s close.
-2% -1% 0% 1% 2% Past performance is no guarantee of future results.
Looking Ahead
Upcoming Economic Releases BofA Merrill Lynch Global Research
Key Year-End Forecasts
On Tuesday, the National Federation of Independent Businesses
publishes its Small Business Optimism index for April. The consensus S&P 500 Outlook 2017 E
forecast is for a stable reading of 104.0 following one of 104.7 Target 2,450
in March. Investors may be on the lookout for any softening of EPS $129.00
recent high levels of confidence given uncertainty on the timing Real Gross Domestic Product 2017 E
and magnitude of fiscal stimulus from Washington. Global 3.5%
On Friday, the U.S. Bureau of Labor Statistics is set to release its U.S. 2.1%
reading of consumer price inflation for April. BofAML Global Research Euro Area 1.7%
expects a month-over-month increase of 0.2%, rebounding from a Emerging Markets 4.6%
0.3% drop in March.
U.S. Interest Rates 2017 E
In the Eurozone, on Friday investors will be awaiting Eurostat’s report Fed Funds (eop) 1.38%
on industrial production for March. BofAML Global Research expects
10-Year T-Note (eop) 2.85%
year-over-year growth of 1.7% on a workday-adjusted basis.
Commodities 2017 E
Gold ($/oz-period average) $1,286
WTI Crude Oil ($/bbl-eop) $59.00
All data as of last Friday’s close.
CIO REPORTS • The Weekly Letter 3
CHIEF INVESTMENT OFFICE
Christopher Hyzy
Chief Investment Officer
Bank of America Global Wealth & Investment Management
Mary Ann Bartels Karin Kimbrough Niladri Mukherjee
Head of Merrill Lynch Wealth Head of Investment Strategy Director of Portfolio Strategy,
Management Portfolio Strategy Merrill Lynch Wealth Management Private Banking & Investment Group (PBIG)
and International
Nicholas Giorgi Tony Golden Emmanuel D. Hatzakis Marci McGregor Rodrigo C. Serrano John Veit
Vice President Director Director Director Vice President Director
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