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Fast Trading South of the Border: Is Mexico Set For A New Market High?

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The Mexican stock market is ripe for both asset appreciation and electronic trading. I spoke at an unusually well-run and  meaty RiskMathics event on Algorithmic and High Frequency Trading recently in Mexico City.

Mexican traders, investors and exchanges see the same series of  "fiasco" headlines on electronic trading we see, from the Flash Crash, to BATS to Facebook to Knight Capital.

They'd like to avoid the mistakes made in the US, an admirable idea.  They start out simple - one exchange, one regulator, so they have reason to be hopeful.

A stable market is likely good for investors as well, since the Mexican market is undervalued by Warren Buffet's favorite value measure, the ratio of GDP to Market Capitalization. The curious reader can find the details on this here. But in a nutshell, we can categorize markets using this ratio as undervalued, fair valued, or overvalued as shown below. The US, as of last week, was fair valued.

 
Ratio = Total Market Cap / GDP Valuation
Ratio < 50% Significantly Undervalued
50% < Ratio < 75% Modestly Undervalued
75% < Ratio < 90% Fair Valued
90% < Ratio < 115% Modestly Overvalued
Ratio > 115% Significantly Overvalued
Where are we today (11/24/2012)? Ratio = 89.5%, Fair valued

The range for the US, seen below, has seen quite a bit motion in the recent past, ranging over a factor of five from 35% to 150%.

The current US value of 89.5% would say US stocks are fairly valued.

So what is the story in Mexico? The most recent GDP, for 2011 was $1.74 trillion in US dollars, and the market capitalization $460 billion, in USD (both figures are from the World Bank).

To save the trouble of whipping out the calculators (or using Google's search to do arithmetic - a very cool feature), this puts the GDP/TMC ratio for Mexico at slightly less than 38%, indicating a significantly undervalued market and a potentially significant investment opportunity.

In the larger scheme of things, one of the problems holding the ratio down, has been the large "off the books" component of the Mexican economy. However, if the legalization of marijuana  seen in the votes in Colorado and Washington state proves to be a larger trend, these activities will be increasingly legitimate south of the border and could lead to a new "market high."