China plus one: Mexico and Vietnam

Mexico and Vietnam benefit from the «China plus one» model, in which China-dependent companies add a non-Chinese supplier.

According to Morgan Stanley Institutional Fund, stock selection and an overweight allocation to Mexico contributed in 2022 to relative performance, led by the allocation to one of the country’s largest banks. 

From this fund’s perspective, Mexico has emerged from the pandemic in a better macroeconomic position than it was going in, with strong growth in both real and nominal terms. 

Going forward, it added, the country’s economy should continue to benefit from trade and economic ties with its main trading partner, the United States. 

The fund noted that the administration of President Andrés Manuel López Obrador has demonstrated fiscal rectitude, even as the state has increased its role in the oil and electricity sectors.

Many companies are reviewing their supply chain management practices to promote greater resilience, even at greater cost. 

For some companies, this may include diversifying suppliers by country and increasing «near offshoring,» locating production closer to domestic markets.

So far, Mexico’s economy has maintained its positive momentum. Preliminary GDP registered annual growth of 3.3% during the third quarter of 2023, accumulating eight consecutive quarters of growth. 

Last February, J.P. Morgan reported that «…Mexico’s case is particularly important for the U.S. given its geographic advantage; low labor costs; and the existence of a 30-year North American trade agreement. In fact, low costs and logistical advantages are the two pillars of nearshoring.»

China plus one

Another case in point is Vietnam. Its structural macro history is compelling: Vietnam remains a high-growth country driven by external sources such as exports and manufacturing, and its strong human and financial capital allow it to be one of the few countries that continues to globalize in a de-globalizing world. 

In addition, Morgan Stanley Institutional Fund notes that a growing consumer class is emerging, with the middle class expected to add around 37 million new consumers by 2030. 

Although Vietnam faces short-term cyclical challenges from tightening macroeconomic and financial conditions, given its global trade linkages and economic ties to the United States and the recent credit boom, the country should be in a position to benefit from both the reopening of China and offshoring from countries and companies seeking a China-plus-one manufacturing strategy. 

The country’s young, tech-savvy and expanding middle class is giving way to a new generation of consumers that should help drive the growth of this NextGen economy.

Asia

Some investors underestimate China’s hard-to-replicate manufacturing position. 

Supply chain changes are coming, but they will be gradual. 

Vietnam is well positioned to benefit in the long term from supply chain changes thanks to its young, educated workforce and its economy, which has been primed for semiconductor and apparel manufacturing. 

India, Indonesia and Malaysia have benefited to a lesser extent. 

India is increasing its domestic manufacturing through its product-linked incentive scheme, which offers incentives for incremental sales of domestically manufactured goods.

The crackdown on leverage among real estate developers has exacerbated China’s real estate crisis. 

The problem is somewhat larger than reports suggest and there continues to be concern about leverage in the broader economy. 

Given that government stimulus is relatively moderate, it will take time to stabilize the housing market, even after the changes announced at the recent Chinese Communist Party Congress.