Mexico Reaps Growth's Dividends

Mexico Emerges

Trade deals, a surge in manufacturing, and a burgeoning middle class are boosting Mexico's economy. A new government is attempting to bring about structural reforms that would increase wages, improve education, and reform taxes, making the country a promising long-term investment opportunity.

Only four years ago, a drug war, widespread poverty, and rampant political corruption hobbled Mexico's prospects so deeply that the U.S. government declared the country at risk of becoming a "failed state." While Mexico continues to battle crime and poverty, the nation has made tremendous strides recently toward getting its economy on a sustainable growth track and repairing its blighted image.

Mexico's recent success started with a flurry of free-trade deals it signed beginning in the late 1980s. Partly as a result of these deals, an increasing number of multinationals have set up shop in the country to capitalize on its inexpensive labor and proximity to the U.S. The manufacturing surge has been driven by rising wages in China, higher transportation costs, and demand for faster turnaround times among U.S. businesses. Mexico's banking system and corporate governance rules have also improved, making investing in the country more attractive. These factors have contributed to Mexico's strong growth in recent years, which has helped move more Mexicans into the middle class and increased consumer spending.

Mexico City's Heavy Traffic

For much of the past decade, Brazil captured Latin America's spotlight. That's not surprising, given that Brazil accounts for nearly 60% of the MSCI EM Latin American Index and its stock market surged a cumulative 921% in the 10 years through 2012. Brazil remains a powerhouse, and T. Rowe Price analysts and portfolio managers continue to identify high-quality Brazilian companies trading at reasonable valuations.

But while Brazil's economy has weakened over the past two years due to slowing raw materials demand from China, Mexico's growth has remained surprisingly resilient. The country's gross domestic product (GDP) grew faster than Brazil's in 2011—the first time it had done so since 2006—and appears set to eclipse it again in 2012, although the data have yet to be determined. The difference in growth rates has helped draw foreign investors into Mexican stocks. The country's domestic IPC Stock Index has outperformed Brazil's Bovespa Index since early 2010 and climbed to record highs at the end of 2012.

"Because Brazil has slowed, investors want to look at the next most obvious market in Latin America, which is Mexico," says José Costa Buck, portfolio manager of the T. Rowe Price Latin America Fund, which invested about 62% of its assets in Brazilian stocks and 21% in Mexico as of the end of 2012. Another 9% of the portfolio is invested in Chile, which also boasts a growing middle class. The portfolio also has exposure to the region's fast-growing markets of Argentina, Peru, Panama, and Colombia. Costa Buck, who travels extensively throughout the region, recently reduced the allocation to Mexico due to the strong rally, which he believes has pushed up stock prices to expensive levels. However, he says, the country's long-term prospects are favorable.Mexico City's Business District

Mexico has gained much of its growing appeal as a manufacturing platform at the expense of China, which is losing some of its luster as the world's low-cost producer. "Some of the companies in which we invest view Mexico as the new China because it is a relatively low-cost manufacturer, and costs associated with China have risen," says Greg McCrickard, portfolio manager of the T. Rowe Price Small-Cap Stock Fund, which has invested in U.S. companies that have benefited from "nearshoring" by moving part of their production to Mexico.

Curt Organt, a T. Rowe Price equities analyst, recounts the story of a manufacturer of commemorative plaques and memorials that moved part of its production to Mexico from the U.S. due to rising materials costs. "When you're faced with higher basic materials costs, you can either increase the price of your product or reduce labor costs," he explains. "By relocating a portion of its manufacturing to lower-cost areas, the company was able to weather the rise in commodity prices."

*Ferrocarril Mexicano was not held by any of the funds in this article as of 12/31/12.

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