Rally Ends at U.S. Border as Mexico, Canada Trail

Mexican and Canadian stocks are returning the least in 14 years versus the Standard & Poor’s 500 Index, a break from a history of matching or beating the benchmark gauge since the countries formed a free-trade agreement in 1994.

Mexico’s IPC Index has dropped 8.2 percent in 2013 and Canada’s S&P/TSX Composite (SPTSX) is up 2.6 percent, compared with the 16 percent advance in the S&P 500. They’re lagging behind the U.S. after two decades in which annual gains in Latin America’s second-biggest economy were 12 percentage points higher and shares in Toronto tripled.

Adoption of the North American Free Trade Agreement has proved a boon for investors, tightening ties in Mexico and Canada to U.S. markets and linking their economies. Money managers from USAA Investments’ Wasif Latif to Franklin Resources Inc.’s Stephen Lingard say the disparity is temporary and that this year’s divergence will close as valuations return to their historical norms.

“Over the long run, these markets tend to move fairly close with each other and in tandem, so this recent divergence will revert back to that long-term relationship,” Latif, the San Antonio-based vice president of equity investments for USAA, which oversees $54 billion, said by telephone. “The U.S. market has done well, but when you think of the valuation and outlook that’s priced in in terms of continuing growth in earnings and margins, we think it’ll be under pressure.”

Commodity Shares

A gauge of commodity shares in Canada such as Teck Resources Ltd. and Goldcorp Inc. has fallen 23 percent this year for the market’s biggest decrease. America Movil (AMXL) SAB, the largest company in Mexico’s IPC, has tumbled 16 percent. While record profits and Federal Reserve stimulus have driven U.S. shares to records this year, stocks in Mexico have gained about 17-fold and Canadian equities have tripled since 1994, compared with a 260 percent rally in the S&P 500, the data show.

The nations are part of Nafta, the trade accord passed during the administration of U.S. President Bill Clinton that reduced barriers to investment and commerce. Creation of the world’s largest duty-free bloc lifted tariffs on the majority of goods produced by members and gradually eliminated remaining obstacles to investment over 15 years, according to a joint government website.

While opposed by American labor unions, benefits of the agreement have included a larger pool of workers for U.S. companies and greater access to natural resources. Mexico and Canada were bound more tightly to the world’s largest economy as impediments to trade were eliminated.

U.S. Confidence

“You’d expect these two countries to follow more with the U.S., but each one has its own issues,” Paul Christopher, the St. Louis-based chief international strategist at Wells Fargo Advisors, said by telephone. His firm oversees about $1.3 trillion. “Monetary easing has really helped regain some level of confidence in the U.S.”

Canada and Mexico accounted for 16 percent and 13 percent of all U.S. trade last year, according to Census Bureau data. Trade to those two markets totaled $1.11 trillion, double the amount with China and more than five times Japan, the data show.

For Canada, about 75 percent of total exports went to the U.S. last year, government figures show. The U.S. bought about 80 percent of Mexico’s exports last year, led by oil, cars, auto parts and flat-screen televisions.

Correlated Expansion

The three economies have expanded and contracted together in 16 of the 19 years since Nafta was enacted, data compiled by Bloomberg show. Annual growth averaged 2.5 percent in the U.S. and 2.7 percent in both Canada and Mexico since 1994.

The same is failing to hold in stocks. While the S&P 500 reached new highs this week, in Canada, where commodity companies make up almost 40 percent of the market, equities are little changed after gold and copper tumbled. Mexican (MEXBOL) equities, where America Movil’s influence is almost twice as great as any other stock, are at an eight-month low after programs to foster business competition and bolster growth by President Enrique Pena Nieto hurt phone companies and builders.

Detour Gold Corp. and Iamgold Corp. helped lead declines in Canada as gold and silver mining companies made up nine of 10 biggest losses in the S&P/TSX this year, tumbling more than 49 percent. Bullion futures have dropped 19 percent in 2013, poised for the first annual decline since 2000, after some investors lost faith in the metal as a store of value.

China Slowdown

The slowdown in China, the world’s largest consumer of raw materials, has caused a bear market in commodities from copper to silver and iron ore. Gross domestic product will probably expand 7.6 percent this year, down from an earlier forecast of 7.8 percent, JPMorgan Chase & Co. said in a report this month, citing weak domestic demand. China producer prices slid 2.6 percent in April from a year earlier, government data showed this month.

“If we see a strong revival in China, Brazil, those areas of the world that give a lift to resources, we could see gold rebound and this divergence could be over in a heartbeat,” Andrew Pyle, fund manager with ScotiaMcLeod Inc. in Peterborough, Ontario, said by telephone. He manages about C$210 million ($208.6 million). “A lot of it depends on the outlook for emerging markets.”

In Mexico, the 16 percent slump in America Movil, which is controlled by billionaire Carlos Slim, has accounted for about 40 percent of the IPC’s decline this year. The shares retreated as lawmakers last month passed measures to boost competition among phone companies to increase investment and reduce prices.

Government Subsidies

Homebuilders have posted the biggest losses in the IPC after the government shifted subsidies to promote capital-intensive apartment buildings in urban areas over single-family houses in commuter towns or the countryside. Desarrolladora Homex SAB, Corp. Geo SAB and Urbi Desarrollos Urbanos SAB, the largest homebuilders, plunged at least 67 percent this year.

“There are several stocks that have a high weight in the index that have underperformed because they could be hit by reforms,” Luis Rodriguez, the director of research at Casa de Bolsa Finamex SAB in Guadalajara, Mexico, said by phone. “America Movil is having a rough time because their dominance in the market will probably be challenged by regulators. Homebuilders are having a terrible performance.”

U.S. profit growth is slowing after a four-year expansion. S&P 500 earnings are projected to increase 9.2 percent in 2013, compared with 35 percent and 15 percent in 2010 and 2011, respectively. About 71 percent of companies exceeded analysts’ income estimates in the first quarter, while 52 percent missed sales projections, based on data compiled by Bloomberg of companies that have reported quarterly results.

Cheapest Level

The S&P 500’s valuation relative to estimated operating earnings in the next year has risen 37 percent since October 2011, more than the multiple for the IPC and S&P/TSX, according to data compiled by Bloomberg. Canadian stocks are trading at 14.5 times forecast profits, the cheapest level relative to the U.S. in four years.

“People are paying a lot for safety,” said Lingard, who helps manage $27 billion as research director and fund manager with Franklin Resources’ Franklin Templeton Multi-Asset Strategies group in Toronto. “In the next 12 months, if global growth comes in stronger, then some areas where Canada is exposed to a greater extent than the U.S. are just too cheap.”

The rout in Canadian materials companies has overshadowed gains by nine out of 10 groups in the S&P/TSX. Technology companies have led the advance in 2013, rallying 29 percent as investors made bets that BlackBerry (BB) will be successful in its turnaround with a new lineup of smartphones.

Merger Speculation

Health-care stocks posted the second-biggest increase, led by Valeant Pharmaceuticals International Inc. The Montreal-based maker of Zovirax cold-sore cream and Kinerase skin conditioner has jumped 31 percent this year amid speculation it will merge with Actavis Inc.

Mexico saw its first credit upgrade since 2007 this month. Fitch Ratings boosted the country’s credit rating to BBB+, the third-lowest investment grade level, from BBB on May 8. Pena Nieto, the Mexican president who took office in December, has pledged to push through legal changes to boost tax collection and open the state-controlled energy industry to more private investment.

“The reality is that the trickle down from the U.S. probably takes a little longer,” James Dunigan, who helps oversee $112 billion as chief investment officer in Philadelphia for PNC Wealth Management, said by phone. “It’s still a weak recovery compared with past recoveries but nonetheless, it’s much stronger than the rest of the globe.”

To contact the reporters on this story: Inyoung Hwang in New York at ihwang7@bloomberg.net; Eric Lam in Toronto at elam87@bloomberg.net; Julia Leite in New York at jleite3@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net; David Papadopoulos at papadopoulos@bloomberg.net

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