EWW: Mexican elections sell overreaction

More people will vote in 2024 than ever before. At least 64 countries will hold national elections, and this will create a lot of volatility in the market. It should also create a lot of opportunities.

Mexico went to the polls on June 2, and on Monday it was clear that Claudia Sheinbaum would become the country’s first female president. The landslide victory caused a significant negative reaction in the Mexican markets. The peso fell sharply, as did stocks. iShares MSCI Mexico ETF (NYSEARCA:EWW) ended the session down 11%, the biggest single-day drop since Covid.

I think this may be an overreaction, and history tells us that election sell-offs are often a buying opportunity. EWW could be a good fund for a potential rebound in Mexican stocks.

The election

The election result in itself was not a shock. Sheinbaum was consistent and comfortable He led the ballot by about 20%. The surprise and driver of the market fluctuations was the overwhelming majority that Sheinbaum and the ruling party were able to achieve. Sheinbaum won just over 60% of the vote, the highest vote share since 1982. Her main rival, Xochitl Galvez, attracted only 28% of the vote.

Morena will have a strong majority in the House of Representatives and the Senate, and it is feared that this will give them the freedom to make changes to the constitution and implement policies that are unfriendly to markets and business.

Another fear is the independence of the Bank of Mexico, which may be pressured to support Morena’s policies. A large fiscal deficit of about 5.8% is expected this year, and Sheinbaum promised to expand the welfare policies that have boosted the incumbent president’s popularity. The peso fell about 3% after the election results amid fears of a ballooning deficit and a possible credit rating downgrade for Mexican sovereign debt.

Sheinbaum clearly noticed the market reaction and, as JPMorgan noted in a note to clients, “sought to calm markets by emphasizing that its management would ensure an independent central bank, maintain a division between economic and political powers, adhere to legality and maintain a disciplined system.” . Financial position.”

This conciliatory tone may help calm markets, and there is no immediate danger from the new policies. President Obrador has proposed major constitutional reforms, but these will only be possible after new lawmakers are elected on October 1. When asked if he would follow through with these changes, Obrador said:

“We need to be on the same page to discuss these initiatives with Claudia, as well as other things we need to work on together… I don’t want to impose anything.”

Market reaction

As mentioned earlier, the markets fell sharply. The Mexican stock market fell 6% on Monday, and EWW closed down more than 10%. This was a knee-jerk reaction provoked by the surprise majority.

While we often associate black swan events with major accidents, election surprises also fit the definitions described by Nassim Nicholas Taleb.

1. The event is a surprise (to the observer).
2. The event has a huge impact.
3. After the first recorded instance of the event, it is justified in hindsight, as if it were so could It was expected; That is, relevant data were available but were not accounted for in risk mitigation programmes.

Markets always react the same way to negative surprises – sell first, ask questions later, and always protect capital. It is also common for the initial reaction to be completely recovered, as this Seeking Alpha article explains.

Obviously, how long this takes depends on the seriousness of the driver, but in this case, the immediate risk appears very low. In fact, the EWW sell-off lasted exactly one day, and good support settled at $57.51.

Prices have since recovered to return to Monday’s open. It would be natural for this bounce to continue near $64, where the decline began and broke the key support at the 200dma and 2024 lows.

Monday’s decline shook positions and this may give new momentum to the rise. For example, some investors are likely to be afraid to exit their positions. If they see prices rising again and realize they made a mistake by closing, they may buy back at a higher price. Short sellers will also provide a tailwind if they are squeezed and forced to buy back their positions. If EWW closes back above the $64 level, it has a good chance of continuing towards the high of $71.

Why EWW?

EWW was launched in 1996. It is a passively managed fund that tracks the MSCI Mexico IMI 25/50 Index. According to the prospectus, the index is:

…a free-float-adjusted market capitalization-weighted index designed to measure the performance of the large-, mid-cap and small-cap sectors of the Mexico stock market.

Here are some important metrics –

A low PE ratio of 10 is attractive, while a dividend yield of 2.27% is reasonable. An expense ratio of 0.5% is high.

As I view EWW as a play for post-election recovery and rally, its diversification and “exposure to a wide range of companies in Mexico” are key. The fund owns 48 stocks in six main sectors.

A 60% weighting in the top 10 is high, but is a common feature of market cap-weighted funds/indexes.

EWW has a close counterpart, which is… Franklin FTSE Mexico ETF (FLMX). There’s not much to differentiate it from EWW, but it has a lower expense ratio of 0.19%. The total returns at EWW and FLMX are almost identical.

Risks

Markets fear that Sheinbaum will undertake negative market reforms and pursue policies that would jeopardize Mexico’s economy and credit rating. If these fears come true, EWW is at risk of falling through this week’s low at $57.51, which would subsequently break the long-term trend channel.

Investing in Mexico involves country-specific risks as described in the prospectus.

Conclusions

The size of Sheinbaum’s landslide victory alarmed markets in Mexico. Monday’s knee-jerk reaction sent EWW down 11%. However, longer-term support has held and a recovery appears to be underway as it is common for markets to recover from surprising events, especially when near-term risks are low. EWW is a way to identify any post-election rally, and can be replaced with FLMX since the two funds are very similar.