The Mexican Peso Is on the Verge of Collapse

It was a busy June in foreign elections – and the financial markets aren't happy about it...

Last month, we looked at how Indian stocks sold off following the nation's election. And on June 2, a similar situation happened in Mexico.

Mexican stocks dropped 6.1% the day after the country's elections. The results clearly shook investors' confidence. But the bigger story here is about Mexico's currency...

The peso is down double digits in just the past month. And unfortunately, we shouldn't expect the currency to shake off those losses.

Instead, history tells us the recent decline could spiral into a major collapse...

Claudia Sheinbaum won the Mexican presidency on June 2. She'll be the first female president in Mexico's history. And she won the election by a landslide – 32 percentage points to be exact.

The sweeping victory gave Sheinbaum's left-wing Morena party a near supermajority in Mexico's equivalent of Congress. They're now just two votes shy of being able to change the country's constitution on their own.

Investors are worried this could bring about an antibusiness environment. Mexican stocks crashed as a result. And the Mexican peso suffered a similar decline.

The currency has dropped as much as 12% since May, hitting a year-plus low in the process. Take a look...

As contrarians, we might be tempted to believe that this sell-off has gone too far. After all, investor fears rarely match up with the eventual reality. Mexico might not make the sweeping governmental changes that folks fear.

Still, there's another reason to expect the decline to continue. That's because traders were overly bullish on the peso before the election... And they still are, even after the recent drop.

We can see this by looking at the Commitment of Traders ("COT") report. This shows what futures traders are doing with their money. When these folks are all betting in the same direction, the opposite tends to occur... which makes this report a valuable contrarian indicator.

Recently, trades on the peso hit some of the most bullish levels we've seen in the past 15 years. Take a look...

Futures traders were all betting on a stronger peso. And despite the recent double-digit decline, that hasn't changed much... which means this currency likely has more room to fall.

History brings us to the same conclusion. Here's what happened after similar setups over the past decade and a half...

The peso has gone through its fair share of volatility since 2009. And looking back, sentiment setups like today's were a sure sign of losses ahead.

After similar instances, the average decline was 20% in about eight months. That means we can expect the losses to continue... And in a worst-case scenario, the peso could collapse more than 30%.

As a U.S. investor, you might not usually pay much attention to Mexican stocks or the peso. But this shake-up is worth keeping an eye on in the months to come.

It could eventually set up a contrarian opportunity. But for now, it's best to steer clear. The losses are likely to continue.

Good investing,

Brett Eversole

Further Reading

French stocks sold off last month in the wake of a surprising election result. This turbulence won't last for long. But the current volatility could offer a solid contrarian opportunity... Learn more here.

"The Japanese yen is in the middle of a collapse," Brett writes. Many investors have left the currency for dead as a result. But history tells us a sentiment reversal could likely happen soon – and a sustained rally is possible... Read more here.