Zaks Investment Advisory Service

BRIC Alternatives: Mexico and South Africa

Last time, we tried to figure out which emerging nations besides the BRIC countries could potentially interest US investors. I finished my last program by noting that of the more developed nations, our best candidates include Mexico, South Africa, Turkey and South Korea. But before moving on to emerging markets, I would like to remind you that the past week was one of the most successful on our own market in 2008: the S&P 500 index gained 4.3 percent. The risk premium fell as well: a month ago, it reached the record level of 10 percent, but by Friday, it had slipped back down to 7.8 percent (see market notes on this subject). And another positive detail: the market recorded a substantial gain Friday. Not that long ago, traders would try to dump their stocks toward the end of the week, fearing that the weekend was more likely to bring negative rather than positive news, which could then hurt their open positions. But traders are no longer driven by that fear, and this attests to things taking a positive turn on the market.

But now, on to Mexico. Over the past five years, the Mexican stock exchange index gained about 400 percent, something that cannot help but attract investors’ attention. The Mexican exchange is Latin America’s second-largest behind the Sao Paulo one in Brazil. But the history of Mexico’s economy, just as that of all other emerging nations, is not a simple one. Over the course of many decades, it was squeezed by both trade unions and the state. In recent years, the Salinas, Fox and current Felipe Calderon presidential administrations have all made substantial efforts to liberalize the economy. In 1994, Mexico signed a trade agreement with the United States and Canada called NAFTA. This agreement helped Mexico boost trade with its northern partners. I would like to point out that while some jobs do relocate from developed nations to developing ones, most of the competition occurs between the developing nations themselves. Without NAFTA, it is unlikely that Mexico could have posed much of a challenge to China. But thanks to NAFTA, many US companies now open their own subsidiaries in Mexico instead of stocking up on Southeast Asian goods. Such enterprises are most often set up near the US border and even have their own name – maquiladora.

Even though the Mexican economy is growing, the country is still experiencing many of the difficulties common to emerging nations. For example, the income gap between Mexico’s poor and rich is vast (as we’ve already mentioned, the same problem exists in most other Latin American countries): the economic circumstances of hundreds of thousands of Mexicans are forcing them to illegally emigrate to the United States. Yet at the same time, Carlos Slim, owner of the Telmex and America Movil companies, is the second-richest person in the world, with an estimated fortune of 60 billion dollars. He obtained a portion of this wealth with the helping hand of president Salinas following the privatization of Mexico’s telephone companies. So in this respect, Carlos Slim is not that different from the Russian oligarchs. Mexico also has large oil reserves. But the government has historically used the state-owned Pemex oil company as its own personal piggybank. The company lacks the finances to develop new deposits and Mexico’s oil production has fallen as a result. Yet Mexico’s constitution forbids the privatization of Pemex. Besides, trade unions are fighting any attempts to change the situation. You may have heard that last week, leftist party representatives barricaded themselves inside the country’s Congress in an effort to prevent the discussion of a draft law that would have allowed Pemex to hire Western companies to conduct exploration and other works. But despite it all, modern Mexico still has a relatively open market economy that could potentially enjoy faster rates of growth. It is thus a candidate for investors interested in emerging markets. Investors have access to several mutual and closed-end funds, along with exchange-traded funds.

South Africa has a smaller economy than Mexico’s, but a higher per capita GDP. Over the past five years, stocks on the Johannesburg exchange gained about 300 percent: slightly less than in some other emerging nations, but much more than witnessed either here or in Europe. The South African economy still retains some shadows of apartheid: on the one hand, the Johannesburg stock exchange is the world’s 17^th largest by volume of trade, bigger than many of the European exchanges. On the other hand, much of the country’s population lives in poverty. South Africa’s life expectancy is catastrophically low, mostly due to AIDS. But that is not the main point. What is most important is that South Africa has chosen the path of reconciliation, and its modern economy is integrating the country’s black and white populations. A country like Zimbabwe is currently demonstrating how events could have otherwise unfolded: thankfully, South Africa has made a different choice.

In terms of finances, the republic’s authorities are following a conservative policy and keeping the budget deficit in check. Overall, South Africa’s economy is one of the most open in the developing world. In addition, the country boasts a modern infrastructure. South Africa exports gold and many other mineral resources. The recent rise in the price of gold has further helped the economy out. But exports represent only a small share of the economy; the largest is made up of services – just as in developed nations. As for the problems – there are many. One of the main ones, as in Mexico, is the divide in living standards between the rich and poor. In South Africa, it is gigantic – one of the largest in the world. This creates potential political problems and turns into an investment risk. On the other hand, if the country is able to resolve its political and social problems in a peaceful manner, South Africa has colossal prospects. These are tied to both the developed nature of its domestic market and the central role the country plays on the southern African continent. To take advantage of South Africa’s investment opportunities, US investors could use several mutual and closed-end funds, as well as an ETF, which is based on the Johannesburg stock exchange index.

And with that, we will draw today’s program to a close. This was Sergey Zaks. Thank you for your attention and until next time.