Betting On the Mexican Markets Boom

NEW YORK ( TheStreet) -- Mexican markets have been sizzling. During the past year, iShares MSCI Mexico ( EWW) returned 22.5%, compared to 12.3% for the MSCI EAFE international index, according to Morningstar.

A strong economic showing has been boosting Mexican stocks. According to the IMF, the country's gross domestic product grew 3.8% in 2012. That's a notable performance at a time when much of the developed world is struggling to grow at 2% rates.

Can the Mexican markets keep climbing so rapidly? Maybe not. After the rally, the stocks are no longer cheap. The Mexico ETF has a forward price-earnings ratio of 16.3. In comparison iShares MSCI Emerging Markets Index ( EEM) has a P/E of 11.2.

Still, investors should not ignore Mexico, which has become one of the most dynamic economies in the world. Corporate earnings in the country are growing at a 14% annual rate. While the ETF could be volatile, there is a clear case for owning Mexican stocks as part of a broader portfolio. "Mexico will still report a lot of growth," says Sophie Bosch, portfolio manager of JPMorgan Latin America Fund ( JLTAX), a mutual fund.

Much of Mexico's recent strength has come from manufacturing. Factories are opening to produce auto parts, televisions, and refrigerators. A decade ago, the picture was very different, as businesses left to find cheaper costs in China. According to HSBC ( HSB), workers in China cost employers 32 cents an hour in 2000 vs. $1.51 in Mexico. But then in the next decade, China boomed, and labor costs skyrocketed, reaching $1.63 in 2011. At the same time, Mexico grew at a slower pace, and costs increased to $2.10.

Even though wages may still be a bit higher in Mexico, the country now has an edge over China because of transportation costs. While it takes up to three months to ship products from China to the U.S., Mexican goods can arrive north of the border in two days.

As oil prices have climbed in recent years, the cost of moving goods across the Pacific has mushroomed. In addition, the value of the Chinese currency has climbed against the dollar. That has made Chinese goods more expensive for U.S. buyers.

Part of the reason for the strong showing of the Mexican ETF has been its sector composition. The fund has 38% of its assets in consumer shares and nothing in energy. That is very different from typical emerging markets funds, which have big stakes in commodities and relatively little in consumer staples. In the past year, consumer stocks rallied, while energy shares lagged as investors worried that a slowing economy in China could hurt demand for commodities. Mexican markets have few big energy stocks because PEMEX -- the country's giant oil producer -- is owned by the government and the shares do not trade on public markets.

The big consumer stake could help the iShares Mexican fund in coming years. As millions of formerly impoverished consumers enter the middle class, they are beginning to shop more in chain stores and buy more staples. The trend toward increasing purchases of household appliances seems likely to continue because banks are beginning to extend more credit.

A holding in the ETF is Fomento Economico Mexicano ( FMX), which owns the largest chain of convenience stores in Mexico and also controls the biggest Coca-Cola ( KO) bottler in the world. Sophie Bosh of JPMorgan owns the stock. "They have been increasing the amount of floor space in the convenience stores and improving the margins," she says.

Another holding that stands to benefit from the growing consumer economy is Wal-Mart de Mexico ( WMMVY). The chain now has $32 billion in sales and is winning over budget-minded Mexican shoppers.

A company that stands to benefit from increased manufacturing in Mexico is Alfa S.A.B ( ALFAA.MX), a conglomerate that makes petrochemicals and aluminum auto parts. "As more car companies come to Mexico, they are buying more parts," says Sophie Bosch.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.