Musings On Mexico's Presidential Election--A Market Waiting for Tomorrow

This July, these five characters will be vying to be the next president of Mexico. The one on the far left--in the picture and the political spectrum--is Andres Manuel Lopez Obrador, or AMLO.  He leads most polls, but the campaign is still in the early stages.

From left to right: AMLO (Morena), El Gato en Saco (PRI), Flaca (Ind), El Joven (PAN), and mi guarura (Ind)

Thanks to his two runner-up showings in 2006 and 2012, the market has convinced itself AMLO’s populist campaign won’t sustain itself and one of the other candidates will emerge victorious by uniting mainstream voters.  I believe political undercurrents and the polling data indicates otherwise, and current market optimism presents an attractive opportunity to sell MXN or buy MXN vol.

First, a quick primer on Mexican politics. The current president is Enrique Peña Nieto, or EPN. He is a member of PRI, a party that has run the government for most of the past eighty years. His presidency has been a disaster. Growth and wages have stagnated, inflation has spiked higher, and the peso has been decimated. People are frustrated with high rates of crime, and dramatically higher energy prices, despite the promises cheaper gasoline and propane following the passage of reforms in 2014.

Corruption has been a big issue too, as allegations have dogged the administration since its early days, as well as PRI governors throughout the country. This has left behind the stench of systematic sleeze, both within PRI and throughout all of the nation’s political parties. Do you really believe Mexico was the only big Latin country to be spared the public works bribe-fest led by Odebrecht? Maybe…..But it seems like a bit of a long shot.  People aren’t buying it.

EPN and PRI have led his administration to unheard of levels of unpopularity in Mexico; only 26% of people approve of EPN’s government. Here is a chart of the approval ratings for this stage in time of last five administrations...none of them come even close to the vitriol generated by the current government.

Source: Mitofsky Group poll, December 2017

And lest you think this is a “class warfare” thing, look at this chart.

EPN approval rating by group:

Source: Mitofsky Group poll, December 2017

This chart says….men, women, rich, poor, uneducated, educated, young, old….they are all united by one thing: a hate EPN.

Well, a hate for two things. EPN and Trump.

People are fed up. All of ‘em. This isn’t 2006. It is going to be a “throw the bums out” type of election.

No doubt about it, AMLO is a divisive name. He is your standard-issue leftist, and talks about import substitution, national pride, how to revive rural economies, and promises to roll back market-friendly energy reforms, amid a broad “power to the people” theme. Financial markets panicked in 2006 when it looked like he might win, and there has been no signs that his rhetoric has softened in the intervening twelve years.

AMLO will run against PRI’s Jose Antonio Meade, and Ricardo Anaya, the leader of the center-right PAN, as well as a couple of independent candidates who have yet to show any signs of life.

Meade is perhaps one of the weirdest candidates I have seen from an establishment party in any country. He’s not even a member of the party. He’s a life long bureaucrat, with high marks for basic competency, but has never run for office at any level. In contrast to any other PRI politician, he’s clean as a whistle--but has the all the election campaign charisma of an old house cat.  

AMLO leads early polls by between 3 and 12 points. But financial markets are desperate to believe Meade will somehow find a way. A brilliant illustration of this fact came last week, when I stumbled across this gem in a tweet by Bloomberg journalist Eric Martin:

Now, let’s take a look at a recent poll for a national newspaper by polling firm Buendia & Laredo:

Regardless of the candidate you are planning to vote for, with what you know or have heard, who is the candidate most likely to win the election of President of the Republic?

Source: Buendia & Laredo poll for El Universal, January 29, 2018

Put another way, actual voters believe AMLO will win by a near 2-to-1 margin. There’s a 46% gap between the proportion of actual voters that believe Meade will win, and the business elites in the Santander poll.

Before we look at how that may manifest itself in a trade, let’s look deeper into the polling numbers.

Presidential preference--AMLO leads PAN’s Anaya by 6 points, but a whopping 16 points over Meade.

Source: Buendia & Laredo poll for El Universal, January 29, 2018

Alright you say, but as the election approaches, will  center and right-wing voters unite under an “Anyone but AMLO” flag?  That appears unlikely. First, both Meade and Anaya will have their own problems uniting their constituencies. More importantly,  AMLO is way more popular among supporters of the other two main candidates than they are among his supporters.

In a hypothetical two-way race between AMLO and Anaya, AMLO’s support rises from 32% to 46%, while Anaya’s rises from 26% to 38%.

Source: Buendia & Laredo poll for El Universal, January 29, 2018

The outlook in a two-way race against PRI’s Meade is even more in AMLO’s favor. AMLO’s support goes from 32% to an outright majority--55%. While Meade’s support rises from 16% to a pathetic 26%.

Source: Buendia & Laredo poll for El Universal, January 29, 2018

Another prevailing belief about AMLO is that he has a “toxic brand” among centrist voters, owing to his long history of leftist politics and his decision to dispute the results of the 2006 election. But again this ignores the data--AMLO is BY FAR the most popular politician in the race!

What is your opinion of...

Source: El Financiero poll, February 6, 2018

Maybe there is some chance that Meade can unite the party and take advantage of the PRI “machine” to bring in the middle class and get out the vote in the rural south and northeast. But it is tough to see how, given his personal unpopularity and these numbers:

Source: Mitofsky Group poll, January 17, 2018

59% of people say they would never vote for PRI--a number that has risen materially since Meade’s nomination in November.  With these numbers, Meade might struggle to beat The Donald in a head-to-head race.

Can Anaya and the Frente por Mexico left/right alliance cobble together a coalition to defeat AMLO? Sure, it could happen, especially as the campaign picks up speed and gets into debates where he could excel. As of now, the metrics aren’t suggesting Anaya is gaining any traction, and the machiavellian break between him the Calderonistas led by former PAN first lady Margarita Zavala will continue haunt him so long as she continues her independent bid. By refusing to make peace with Zavala, Anaya signaled to many voters he is just another career politician, exactly the type of figure that many Mexicans claim they are sick and tired of.

Given there is no runoff, Anaya could cobble together 30-35% of the vote between independents, PAN, PRD and dissident PRI voters and hope Morena’s lack of financial resources, campaign experience and “GOTV” machinery dilute AMLO’s electoral performance despite his broad appeal. Even if that happens, it won’t be pretty, and there will be plenty of volatility along the way.   

   

Putting it all together:

• The Anti-PRI/anti-corruption vote is going to be significant
• AMLO is popular, and a likely second choice candidate by many non-supporters
• Meade will have enough trouble uniting PRI, say nothing of the country, behind his campaign,
• Anaya, same thing, but with marginally better chances
• There is little chance of any change in sentiment towards PRI, or a material change in economic fortunes to favor establishment candidates at this stage of the race
• The base case should look for an AMLO victory in July. 

So what’s the trade?

First, politics matter. Another undercurrent in this fantastical EMFX market may be the belief that this is a “kinder, gentler” AMLO and EM investors aren’t that worried about him blowing up the market-friendly system. But just looking at recent history in Argentina, Brazil, South Africa, or even Chile, where equity and FX markets rallied hard after Piñera’s victory in December, and you can’t ignore the power of politics in EM. The result of this election will move the market.

The easy answer is just to buy USD/MXN and be done with it. You won’t get much argument from me on that one, especially after MXN was swept along with the USD fire sale over the past three months. Nobody is making big country-level decisions (ARS and ZAR being notable exceptions). All macro, all the time. Flows.

Source: JP Morgan

Now, over the past week as US equity markets cracked, volaitlity spiked, and short-gamma funds started washing up dead on the beach, high-beta EMFX has been quiet….a little too quiet. You could do a lot worse than to overlay a short MXN position in a risky portfolio.

If you’re too squeamish--or too bullish on EM, I guess-- to buy USD/MXN outright, the currencies in the chart above would be high-carry candidates from the long side.

FX volatility presents an opportunity as well. This is the chart for 3m atm volatility in USD/MXN and USD/BRL--which I included as a “control”--going back to the stone ages in 2010. Today’s level around 12% isn’t too bad at all historically--and certainly seems cheap flat to BRL.  

Source: JP Morgan

Similarly, 3m riskies are flat to BRL and not looking expensive at all. Keep in mind both of these trades give you protection against a global short-gamma freakout or Trump drone-striking NAFTA too.

Source: JP Morgan

Indeed, the 3mo option expiries only give you protection until early May. If you prefer a full six months of protection to get past the election on July 1, those levels look pretty spicy. The 3mo, 3mo fwd atm vol is 17%, which you see in the chart above is higher than most any non-crisis data point. Similarly, the 3mo, 3mo fwd 25d RR is 5.3%, which is higher than anything this decade outside the European debt crisis.

Those levels may pay off, but look overdone relative to spot 3mo volatility. Moreover, while the 3mo vols only take you into early May, the fireworks will likely already be in the air by that time, especially if AMLO has consolidated a significant lead and his rivals appear incapable of staging a comeback. This chart from a Barclays piece last week shows how MXN started to depreciate around this time in the 2006 cycle, when AMLO-risk was particularly acute:

Source: Bloomberg, Barclays

And while that underperformance in MXN in 2006 was triggered by AMLO jumping to the lead in the polls, the peso continued to weaken throughout the campaign, even though it was a tight race right to the end.

Source: Wikipedia, Barclays

Fast-forward back to 2018, and the spec market is still stubbornly long MXN--expect that to change, soon.

Bottom line, three factors set up an attractive trade here:

• A big disconnect between political expectations in financial markets and reality
• Strong signs the market is remembering the divisive, undisciplined AMLO of 2006, and ignoring his broad popularity combined with the utter disgust for the establishment, 
• A currency that has been pushed along by a macro tailwind, ignoring the local scene,
• A vol market that is mis-pricing the timing for a panic--or at least giving you good odds to bet on a shock sooner rather than later. 

So take your pick--buy USD/MXN outright if you think the USD selloff is overwrought, sell MXN vs. an EMFX for a market neutral position, or buy vol to provide some upside for a relatively quick realization that AMLO is likely to be the next president of Mexico. 

Shawn
TeamMacroMan2@gmail.com

@EMInflationista