06/17/96 DEVELOPING MARKETS HAVE A LIFE OF THEIR OWN

DEVELOPING MARKETS HAVE A LIFE OF THEIR OWN
Good bets exist, no matter what happens in the U.S.
In the past, just a whisper about a Federal Reserve interest-rate hike made emerging-market investors reach for the aspirin bottle. Reliant on American investment and often with currency links to the dollar, developing economies used to watch their stock markets move in line with the Dow Jones industrial average. Now, as market bears worry about a Fed tightening before yearend or a big correction in U.S. stocks, the next six months might seem a good time for investors to move to the sidelines.
Not so, insist many emerging-market experts. The close link between the U.S. and emerging markets is unraveling, they say, which means investors no longer have much to fear from the big bad Fed. Many companies in developing countries will do well no matter what happens in the U.S. ``There's a growing-up trend in emerging markets,'' says Michael J. Howell, chief international strategist at ING Barings in London.
``SIFTING.'' One sign of the new maturity is that investors aren't treating emerging markets the way they used to. Fund managers now take a bottom-up approach to stock-picking in developing markets, looking for value or special growth stories. ``Investors are sifting through companies, not just buying indexes,'' says William L. Wilby, manager of the Oppenheimer Global Fund. Investors now appreciate that emerging-market stocks are more likely to move independently of one another, and that it's harder for an entire market to get rocked by a speculative move based on general economic news, either in the developed world or in the emerging market itself.
An example of what Wall Street is calling ``decoupling'' was evident in the first half of 1996, Wilby points out. Even though 30-year U.S. Treasury yields have risen one full percentage point since January, the major Latin American stock markets are up an average of 20%. ``The U.S. long bond used to be a fantastic indicator of what would happen in Latin American equity markets,'' says Wilby. Not this time.
Even though developing markets are going their own way, they are all gaining momentum from climbing direct foreign investment from the likes of Ford, Coca-Cola, IBM, and Unilever--to the tune of $100 billion a year. ``Foreign multinationals see more potential profits there'' than in the developed markets, says Howell. Such capital flows are less volatile than portfolio investment, since they represent long-term commitments rather than short-term speculation.
Another reason to like developing markets is their valuation. Barings' Howell measures a market's costliness by looking at how its average price-earnings ratio compares with the country's five-year real-growth forecast. ``For the developed markets, it's 7; for the emerging markets, it's 2.9. So as a group, [developing-country stocks] are incredibly cheap,'' he says.
READY TO POLKA. So where are the best bets for the second half? Many analysts vote for Central Europe. Poland, Hungary, and the Czech Republic represent the ``best combination of growth and value you can find in emerging markets,'' says Maria-Elena Carrion, emerging-market portfolio manager at Bankers Trust. Carrion believes that the region resembles Latin America in 1991, when investors first discovered it and drove up stock prices 300%.
``Poland stands out most,'' says Suzanne D. Patrick, senior analyst at New York investment firm Arnhold & S. Bleichroeder Inc. Even after running up 48% in dollar terms year to date, Patrick says, the Warsaw Stock Exchange has an average p-e ratio of less than 10, based on current earnings, compared with a historical average of 14.4. Her stock-picking strategy: ``You should be interested in companies that can participate handily in the reconstruction of Poland but that also have a window on the consumer-products boom.''
One example is Kety Aluminum Products, which makes everything from extruded products such as tubes and wires to household goods such as aluminum foil. Another is glassmaker Krosno, providing fiberglass for cars and handmade glass products for consumers. Since these stocks don't trade in the U.S., looking for mutual funds that concentrate on Central Europe, including the Pioneer and Harvard funds, is the easiest way to buy into Poland.
PESO JITTERS. As a region, there's less consensus about Latin America than Eastern Europe, but many veteran investors give two reasons for optimism. One is that despite good stock performances in Argentina, Brazil, and Mexico in the past six months, investors have still not completely recovered from the after-effects of the peso crisis in December, 1994. Portfolio investment in the region is coming off a low base in 1995 and is likely to keep growing. Second, says Bankers Trust's Carrion, growth of gross domestic product in the second half of 1996 for Argentina, Brazil, and Mexico will look good compared with last year's levels. Stronger economies, especially in Mexico, are likely to reinforce investors' urge to get back in the game there.
While analysts disagree on which Latin country will beat the others, many like the same companies. One in Mexico is Coca-Cola Femsa, the soft-drink distributor whose American depositary receipts (ADRs) are already up 35% this year. Another is Bancomer, one of the Big Three banks whose stock price, at less than 50 cents, is considered a bargain.
Brazil is probably the region's biggest question mark. Slower-than-expected progress on deficit-cutting and persistent high interest rates to keep the real strong could be a combination lethal to growth. In addition, some observers believe that as companies restructure, rising unemployment will depress consumer demand in the near term. Still, analysts think some stocks have sizzle, such as Telebras. As Brazil's largest telecommunications company, notes Salomon Brothers analyst Sari Mayer, Telebras is a play on both industry consolidation and overall economic growth. Salomon says the company's ADRs, at $62, are 45% undervalued compared with the stocks of its Latin American peers.
Bulls aren't roaring in unison over emerging Asia, but certain markets are more popular than others. Barings' Howell is optimistic about South Korea because he believes that an interest-rate cut is in the cards and that the bond market will be opened to foreign investment. Another Korea booster is Grace Pineda, who manages the Merrill Lynch Developing Capital Markets Funds and has large holdings in Korea Mobile Telecom. KMT, is a bet on fast-growing cellular subscriptions in a country that, Pineda notes, is not as closely correlated with the U.S. as many other emerging markets have been.
SHINY NICKEL. With the Kuala Lumpur Stock Exchange up 16% so far this year in dollar terms, many investors think Malaysian stocks are overvalued. But Merrily Chiam, chief of research at Nomura Singapore Ltd., recommends two for the long haul: privatized power company Tenaga Nasional Berhad, about to enjoy the fruits of a tariff hike, and infrastructure play United Engineers Malaysia. And Indonesia, a market where investors have so far been relatively shy, offers at least one exciting bet on rising commodities prices: International Nickel Indonesia. According to James Grant, editorial director of Grant's Asia Observer, Inco Indonesia should benefit from rising consumption in Japan as the economy there recovers, even if world nickel prices don't go through the roof.
The easiest way to place your bets is to buy country or regional funds listed on U.S. exchanges. Many are trading at a discount to net asset value, and managers will do the stock-picking for you. If you would rather run your own portfolio, ask the analysts who follow the companies that interest you whether their firms make a market in the stocks. If their own firms don't, they'll know which firms do. Another option is to stick with ADRs. That way, you can look up in your daily paper whether your emerging-market investments are tracking the U.S. or going their own way.
By Joan Warner in New York, with Dave Lindorff in Hong Kong