When U.S. Markets Wake Up, Latin America Parties

If the surprise decision by Alan Greenspan and the Federal Reserve earlier this month to cut interest rates by half a percentage point has given the U.S. markets a slight nudge toward waking from their slumber, it jolted bourses wide awake in another part of the world: Latin America.

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Considering the lackluster performance of Latin American markets in 2000, and the expected economic slowdown in the U.S., it may come as a surprise that Latin American markets have been among the strongest performers in the world thus far. U.S. interest rates have a strong effect on the region, so any rate cuts similarly affect it dramatically. With most analysts expecting the Fed to cut perhaps as much as another percentage point, the rally may be only beginning.

"Fed easing is a major catalyst for [Latin America]," wrote James Upton, Latin American equity strategist for Credit Suisse First Boston in a recent report. "In both previous easing cycles (1995 to '96 and 1998), the equity markets of Brazil and Argentina traded up strongly during the easing cycle itself. Mexico tended to trade well in anticipation of the easing." In fact, equity indices in Brazil and Argentina rose almost twice as much as the S&P 500 and Nasdaq in the 1995 to '96 easing, Upton noted.

The pattern is holding for this round of rate cuts: Key Latin American markets began to rally in late December -- anticipating the Fed's cuts -- and have not looked back since. Brazil's benchmark Bovespa index has risen 17% since the beginning of the year, while Mexico's IPC index, lagging a bit, is up 13%.

Even Argentina, which concluded an agreement with the International Monetary Fund late last year -- giving it some breathing room to solve its fiscal problems -- has seen its benchmark index rise 30% this year. The Dow Jones Industrial Average is actually down slightly since the beginning of the year, and the S&P 500 has risen only 3%, although the Nasdaq is up 15%.

Investors in the major economies of Latin America -- Mexico, Brazil, Argentina and Chile -- keep a close eye on general economic conditions in the U.S., especially interest rate levels. Since the U.S. is the dominant export market for most nations in the region, exports should rise in Latin America when demand picks up in the U.S. in a lower interest rate environment. Central banks in Latin American countries will likely follow suit, also lowering interest rates, thus increasing domestic demand. Even though most economists agree that economic growth is still going to slow in the U.S. this year, interest rate cuts are good news for Latin American equities.

How to Play It

The best method for playing Latin America as a region recently has been closed-end Latin regional funds. There are two: the Latin American Equity fund(LAQ Quote) and the Latin American Discovery fund(LDF Quote), which are up 12% and 14%, respectively, since the beginning of the year. There are also country-specific closed-end funds for Mexico, Brazil, Argentina and Chile, ishares MSCI funds for Mexico and Brazil that track the Morgan Stanley Capital International indices for those countries.

Surprisingly, regional Latin American mutual funds have not yet reflected the gains in the markets. The current best-performing Latin American fund, (PRLAX Quote)T. Rowe Price Latin American, is down 7.9% this year, although it is up 12.2% over the last 12 months.

Otherwise, retail investors face limited opportunities in buying individual companies. Many of the Latin American companies that should thrive when the Fed cuts rates in the U.S. are not traded on U.S. exchanges -- such as the Mexican banks Bancomer and Banacci. One stock that could do well and is traded here is Mexican telecommunications firm Telmex(TMX Quote).

Latin America is arguably due for a rally after poor performances in 2000, when Brazil's Bovespa slipped 11% and Mexico's IPC fell 21% -- despite sound macroeconomic conditions and company performances.

"The valuations are still pretty attractive in Mexico and Brazil," says Eswar Menon, portfolio manager for Loomis Sayles in the firm's Emerging Market and (LSIEX Quote)International Equity funds. He predicts 30% earnings growth, on average, among Brazilian companies in 2001. CSFB's Upton anticipates 15% earnings growth for Mexican companies, yet only 8% for the S&P 500.

To be sure, there are risks for the region, most notably, the possibility of the U.S. entering a much-sharper slowdown than expected, or a recession. High oil prices would also have a detrimental effect, except in oil-producing Venezuela. And Argentina faces difficult economic restructuring.

But overall, the outlook for the region -- especially for the two biggest economies, Mexico and Brazil -- is pretty positive, demonstrating once again the old saying that Greenspan is the central banker not only for the U.S. -- but for all of the Western Hemisphere.