Peso’s Collapse May Crush Third World Investment

Return to the First World?

For investors, that may be the clarion call resounding from Mexico’s deepening financial crisis. As plunging Latin American share prices worsen an already lousy year for “emerging markets” stock owners, the lower-risk allure of U.S., European and Japanese securities may grow.

Some analysts believe that U.S. stocks and bonds in particular are poised to benefit as Americans - and other global investors - reconsider the hazards versus the potential reward in committing money to faroff and usually illiquid Third World markets.

Mexico’s stunning currency devaluation and seeming loss of financial stability since last week have been unnerving even to professional emerging-markets investors, because until this year the country had been considered one of the greatest foreign-market success stories.

“I don’t think one can ignore that Mexico was seen as one of the more blue-chip emerging markets,” said Richard T. Saler, manager of the Lexington Worldwide Emerging Markets stock fund. “To pretend that it’s not going to have an impact (on investors’ attitudes) is kidding oneself.”

It was on the heels of the Mexican stock market’s tremendous 1988-1992 gains that emerging-markets investing in general became fashionable in 1993, leading to a spectacular surge in purchases of international stock mutual funds.

International funds, which had taken in $5.1 billion in new cash in 1992, saw $26.3 billion pour in during 1993, according to the Investment Company Institute. And through October of this year, international funds’ inflows kept up a record pace, reaching $26.7 billion.

The assets of emerging-markets stock funds alone, which had totaled a mere $600 million at the end of 1992, ballooned to as high as $10 billion by last Sept. 30, says fundtracker Lipper Analytical Services Inc. in New York.

But the continuing inflow of cash into emerging-markets funds hasn’t been matched by performance this year, despite a summer rally in many of those markets.

The average emerging-markets stock fund plunged 12.6 percent in the first half of the year, according to Lipper, as the Indian uprising in Mexico’s Chiapas state last January and the fallout from rising interest rates worldwide slammed many Third World markets.

In the summer, a rebound in Mexico and other major emerging markets erased the first-half loss, but the gains proved fleeting. By last Thursday, as other Latin American markets slumped with Mexico, the typical emerging-markets fund share owner was down 10.6 percent for the year.

By contrast, the average U.S. stock fund is off about 2.5 percent this year, while the average diversified international fund (many of which invest mostly in major foreign markets such as Japan, Britain and Germany) has lost a mere 1.5 percent.

It has been possible to make money in emerging markets this year. But the biggest gainers have been some of the smallest and least liquid of world stock markets - places where the typical mutual fund would have very little invested. Bangladeshi stocks, for example, are up nearly 114 percent this year. The tiny Peruvian market is up about 51 percent, and Nigerian shares have gained 41 percent on average.

On the flip side, the year’s big losers have included markets that, like Mexico, had been touted as particularly promising in the 1990s: China, where the Shenzhen market index has plunged almost 64 percent; Hong Kong, off 30 percent, and Malaysia, which has lost about 19 percent.

Of course, any investor taking a chance in high-risk emerging markets should in theory be prepared for raucous volatility. And to their credit, mutual fund investors mostly stayed put during the big winter and spring selloffs in many Third World markets.

But with this latest and more terrifying decline in Latin American stocks, some investment pros worry that the public’s patience is wearing thin.

Meanwhile, long-term U.S. bond yields - and European bond yields - are coming down as more investors assume that both economic growth and inflation in 1995 will be moderate. A continuing bond rally could draw in an increasing number of investors. For U.S., European and Japanese stocks, the renewed attraction is the prospect of another gain in corporate earnings in 1995, with stock prices now at reasonable long-term valuations after this year’s declines - and with considerably lower risk than what’s inherent in emerging-market stocks.

In the long run, there’s no question that emerging markets should offer higher returns commensurate with their higher risk. But for the near term, the glory days of emergingmarket investing may have run their course.