Mexican stocks are on fire this year. Here's what's driving the gains

Published Sun, Mar 12 20239:16 AM EDT

Closer supply chains to the U.S. are giving Mexican stocks a big boost to start the year. The Mexico S & P/BMV IPC , the country's domestic stock index, is up 8.9% in 2023, outperforming the S & P 500 's 0.6% gain. The iShares MSCI Mexico ETF (EWW) , which is made up of Mexican stocks, is performing even better — up 15.2%. EWW YTD mountain EWW in 2023 One key factor driving this early outperformance is "nearshoring," which refers to companies bringing supply chains closer to their home country. In this case, many U.S.-based companies are moving their supply chains to neighboring Mexico, which could lead to even more gains in Mexican stocks. "Nearshoring represents Mexico's best growth opportunity for the next 10 years and it is already occurring," Carlos Capistran, head of Canada and Mexico economics at Bank of America, said in a note Wednesday. "Mexico is a natural candidate for firms to relocate production to serve the US market due to its geographical location, following the fragmentation of global supply chains and the ongoing reversal of the China trade shock of the early 2000s." Nearshoring The move to bring supply chains closer comes as geopolitical conflicts intensify around the world — threatening U.S.-based businesses who rely on factories in other countries to make products, said Harry Moser, founder and president of the Reshoring Initiative. Consumers also grew particularly watchful of the trend as supply chain snarls held up a litany of products amid economic rollbacks during the Covid-19 pandemic . "Instead of optimizing on the pennies, they're optimizing [on the] tens of thousands of dollars by making sure they can assemble and ship the product," he said. Moser pointed to the Russian invasion of Ukraine as another example to underscore the importance of having closer production. More evidence of the trend came with the announcement that electric-vehicle maker Tesla would build a plant in the Mexican city of Monterrey . Morgan Stanley analyst Nikolaj Lippmann called the plant "a big deal for Mexico," adding that the investment firm favors Mexico compared to other Latin American markets. Lippmann said the firm likes stocks directly helped by nearshoring trends, such as the real-estate firm Vesta and airport operator OMA . OMAB YTD mountain The airport company's U.S.-listed shares' performance this year "The 1st wave of Nearshoring was export led and driven by the pandemic and supply chain challenges; electronics played a key role. The next wave is investment driven, in our view, and led by the auto and capital goods industries," Lipmann wrote in a note recently. Mexico can be a best-of-both-worlds solution for U.S. companies because they bring their supply chains closer to home and within an ally's borders without having to pay relatively more expensive costs for labor in Canada or the U.S., Moser said. But there are unique challenges such as a relative lack of automation that the country could improve over time to be a bigger competitor to China. Moser added that it's unlikely some products will ever be re- or near-shored because of where components are located, pointing specifically to iPhones as one example. Pedro Quintanilla Dieck, an emerging markets strategist at UBS, said the trend is mainly seen in the country's Northern region — which is where the new Tesla plant and the airport are — given its focus on production and manufacturing as opposed to the south's emphasis on tourism. It's also a trend that's been most present thus far in industries with some infrastructure already in the country, such as automotive, machinery, metals and medical devices. "We are not necessarily seeing a material impact of nearshoring in the data yet," he said. "But anecdotally, at the micro level, you certainly do have these projects being announced in several sectors and different parts of the country." U.S.-Mexico connection There's also another big connection to the U.S. that is helping Mexico this year: the economic spillover. As the U.S. economy remains resilient despite inflationary pressures, Mexican workers in the country send U.S. currency back to family members still in their home country, Quintanilla Dieck said. That can in turn help the Mexican economy. The state of the government also makes Mexico relatively attractive within emerging markets, Quintanilla Dieck said. He pointed to the fact that the country has fairly moderate debt and no political risks on the immediate horizon as good signs. Quintanilla Dieck also noted that the country's central bank started raising interest rates to curb inflation earlier than many of its global peers, which mean it's further ahead on the path to a peak. "They can't afford to sit back and say, 'Oh, inflation is transitory, so we expect we're not going to raise rates,'" he said. "Inflation expectations in emerging markets are a bit more sensitive." Mexico's best-performing stocks Many of the best performers this year are tied to the industries that stand to benefit from nearshoring. Auto-insurance stock Quálitas has performed the best within the EWW this year with a 40.5% jump. But analysts don't expect that performance to continue, with only 40% rating the stock a buy and an average price target showing shares could fall 7% over the next year. Multiple airport stocks were also among the best performers, including Centro Norte , Pacífico and Sureste. More analysts like Centro Norte, which was also liked by Morgan Stanley's Lippmann, and Sureste than Pacífico. Airline Volaris, the second-best performer within the ETF this year, has the best upside potential on the list at 60%. Also, more than nine out of every 10 analysts rate the stock a buy. On the flip side, financial name Grupo Financiero Inbursa has the worst next year ahead for shares, analysts estimate. The stock is expected to drop 14% over the next year by the average analyst, with just 11% of them holding a buy rating. — CNBC's Michael Bloom contributed to this report