Mexican Standoff

A confrontation in which no strategy exists that allows any party to achieve victory. As a result, all participants need to maintain the strategic tension, which remains unresolved until some outside event makes it possible to resolve it.

https://en.wikipedia.org/wiki/Mexican_standoff

On May 30th, the Trump administration announced stepped tariffs on Mexican imports under cover of the International Emergency Economic Powers Act. Once again it appears to have been a bargaining ploy using the American consumer and farmers as pawns in a game of Chicken as these were “indefinitely suspended” on June 7th – perhaps realizing the signature USMTA was now at risk by this action or the push back by the business community or the fact that Republican Senators realized they did indeed have a backbone (albeit, small).

While I’ve never been a huge fan of ETFs as my view is that an investor is consigning themselves to the average, my preference being to develop a thesis and buy individual companies in support of the idea – with the expectation being the return will be outside the norm (hopefully in a positive manner). That said, I realize ETFs can – and do – serve a purpose and as such I have five in my portfolio, one being iShares MSCI Mexico Capped ETF (EWW). This issue peaked at $44.54 on May 30th before bottoming at $42.64 on June 3rd which is precisely where my order to add executed. Yes, it was luck calling a bottom but it was also a validation of the Headline Risk concept.

One of the first analyses published was that of a short-seller, BOOX research. He does present a decent argument on all counts, save one. This was followed by Liumin Chen’s analysis which missed the same issue. To be fair, I’m now operating in hindsight – post Trump’s reversal, but I did spend most of last weekend forming my conclusion which was the negative tariff impact to EWW was overblown due to one factor. One where you can’t just look at the forest without reviewing the respective trees.

One uncertainty I have with BOOX is his view of a pending peso devaluation as that would likely torpedo any trade agreement and give rise to currency manipulator status. More important is the view that the Consumer Staples exposure is a negative. While it is true that this sector comprises 30.5% of the ETF, only one of the top ten (Walmart de Mexico) has significant Mexican domestic consumer exposure where US imports (tariffs) could be in play. The other two Staples either don’t interact with the US (Fomento Economico Mexicano) or has significant US operations in their own right (Grupo Bimbo with 22,000 US employees). My take is tariffs would slow – but not cripple – the Mexican economy.

Indeed there could be a silver lining for Mexican multinationals that do not import US products. Some brands at the forefront are Tracfone (America Movil), Groupo Mexico (Southern Copper) and the aforementioned Bimbo (Thomas, Entenmann’s, Mrs. Baird’s). Basically these entities could be repatriating US gained profits in inflated USD to Mexico as artificially depressed MXN. A possible spread play that is typically the province of banks and insurers – and an untended consequence that probably escaped the purview of the experts running this show. The icing on the cake? Cemex with 11 plants and 50 quarries in the US. What’s a good border wall without cement and concrete from a Mexican owned company paid for by US taxpayers?

So this is a contrarian play which – so far – is in the money. I believe the real pain would have been felt in the auto and produce industries which do have significant numbers of US workers. Hopefully this is a fire drill that won’t be reenacted any time soon.

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