Wasting away in Margaritaville may sound appealing to those who haven't done some serious goofing off so far in 2002. Judging from returns so far this year, the irrepressible American spirit must be finding solace in other spirits: The top-performing groups in the

S&P 500

include metal and glass containers, up 15.0%; brewers, up 15.8%; distillers and vintners, up 12.4%; and casinos and gaming, up 8.4%.

The mutual fund industry, never shy about hopping on the latest fashion, has responded predictably: Mutuals.com is launching its

Vice Fund today, the first

socially irresponsible

fund with a charter to focus on alcohol, tobacco, gambling and weapons manufacturing. Why get teched when you can get wrecked?

Elsewhere on the good-times-roll front and within the

Dow

,

Philip Morris

(MO) - Get Report

is up 7.8% so far this year.

Procter & Gamble

(PG) - Get Report

, which makes Pringles, has risen 11.9%, while

Intel

(INTC) - Get Report

has fallen 45.5%. The conclusion is inescapable: At this stage of the bear market, Americans far prefer potato chips to microchips.

Ain't It (Rio) Grande?

No matter how we splice and dice the U.S. market to prove the obvious appeal of 1930s-style escapism, the U.S. market just hasn't been the place to be. As we turn the pages on the calendar to autumn, let's follow the sun southward to Mexico, home of tequila and thus the spiritual home of Margaritaville. It's also where the financial history of the late 1990s really began.

Say what? Let's turn the clock back to December 1994, when, in the finest tradition of the Mexican political and economic cycle, the peso collapsed as the then-new president, Ernesto Zedillo, took office. Mexican interest rates shot higher, and in what was to become a pattern, then-Treasury Secretary Robert Rubin engineered a bailout. Remember Tesobonos?

Some would say Rubin really bailed out U.S. investors who forgot that the interest rates on emerging-market paper were so high because the risks are considerable, but let's not quibble over such unpleasantness. The cycle of easier credit, moral hazard and global interventionism on behalf of markets began and continued through the Russian default in August 1998. You know the rest.

Bolsa Booster

The Mexican Bolsa index has been a strong performer by world standards ever since, both in absolute and currency-adjusted terms. The benefits of the North American Free Trade Agreement to Mexican exporters have been large, as was the first peaceable transfer of power from the dominant Institutional Party of the Revolution to Vicente Fox's National Action Party. The Bolsa boasts a large number of stocks whose peso-denominated performance has been stellar so far in 2002:

  • Savia: This agro-technology and financial services firm has risen 123.8%.
  • Grupo Industrial Saltillo: This industrial conglomerate with interests in automotive products and building materials is up 97.4%.
  • Industrias Penoles: This mining group is up 88.0%.
  • Alfa: This industrial conglomerate with interests in steel and petrochemicals is up 69.0%.

The peso, one of the strongest performers against the dollar all through 2001, has fallen 8.4% in 2002, so the above-noted returns have to be adjusted accordingly. Overall, the Bolsa index has lost 3% in peso terms and 10.4% in dollar terms.

The question, of course, is where Mexican stocks can go from here. The prognosis isn't bright. Let's compare the Bolsa with the U.S. market since mid-December 1994, just before the peso's collapse.

Peso Still a Drag on Returns

Source: Bloomberg

The Bolsa has outperformed the Wilshire 5000 in peso terms since that time. It was only an underperformer during the Asian/Russian crises of 1997-1998, but in dollar terms it is pretty much where it was just before the peso collapse. The Bolsa has been stable in dollar terms since the spring of 2000, while the U.S. market has remained in retreat.

Stocks and the Cetes

Much of the Bolsa's strength has derived from a strong disinflation trend as evidenced by the decline in 91-day Cetes, or Mexican treasury certificates: When interest rates fall from 57% in March 1995 to 3.6% today, something good had better happen to your stock market. The lower interest rates pressured the peso lower over the same period, which further boosted the Mexican export sector.

The End of the Line on Rates?

Source: Bloomberg

Of course, you can only go so far with this combination. The weaker peso, while supportive of exports, also raises the costs of imports and thereby dampens the disinflationary process. Higher interest rates, which would support the peso at the cost of economic growth, are seldom good for stocks unless accompanied by an earnings boom.

A common lament in Mexico is that it is so far from God and so close to the U.S. Indeed, its fellow Latin American states look on Mexico with a strange combination of envy and pity for its unique status. Right now, it appears as if Mexican equities are stuck between a rock and a hard place: The country's chief export market isn't growing, its interest rates have stopped falling, and its currency is weakening.

Maybe that person in the hammock next to you in Margaritaville will be a Mexican stockbroker.

Howard L. Simons is a special academic adviser at Nasdaq Liffe Markets, a professor of finance at the Illinois Institute of Technology, a trading consultant and the author of

The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. The views expressed in this article are those of Howard Simons and not necessarily those of NQLX. As a matter of policy, NQLX disclaims the private publication of materials by its employees. While Simons cannot provide investment advice or recommendations, he invites you to send your feedback to

Howard Simons.

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