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EMERGING MARKETS: PEARLS AMONG THE PERILSThere are a few tantalizing trails in the minefield
A global credit easing, launched by the Federal Reserve in the U.S., has buoyed stocks and stanched the bloodletting that started in Asia and gave all emerging markets--and the global financial system--a mighty scare last summer. But behind the new calm, some ugly economic truths remain. They should keep investors on their toes. RUNNING HOT. In East Asia, for example, most major economies except China and Taiwan are locked into low growth or recession, which is likely to extend into much of 1999. ''Large parts of Corporate Asia are under the threat of bankruptcy,'' says ING Barings strategist Matthew Merritt in London. Besides, a price bust in commodities from oil to copper is pounding export earnings and government revenues in countries such as Russia, Mexico, Venezuela, and Indonesia. And if there's another government debt default in Russia, say, or the International Monetary Fund-led bailout of Brazil collapses, another rout could occur. So if you're considering getting back into emerging markets, stick to stocks of companies boasting strong cash flow, a niche, or a product edge--and in countries acting to solve their deep structural problems. South Korea is a case in point. After the market plunged 60% in 13 months through June, global fund managers returned in droves because the Koreans looked serious about reform. But now the market is showing signs of overheating. Earnings are still dismal, and a flood of equity offerings from cash-strapped companies could drive prices sharply lower in the first half of 1999. Merrill Lynch & Co.'s Seoul-based equity research head, Kim Hun Soo, favors a handful of big players, including Pohang Iron & Steel Co., one of the world's most efficient producers, and Samsung Electronics Co., because its position as the world's biggest memory-chip maker still enables it to generate profits. WILD CARD. In Hong Kong, the key question is whether the rebound in real estate that began in November will hold. It's crucial because property stocks still represent about 22% of the Hang Seng Index's capitalization. Trouble is, the economy contracted at an annual 7% pace in the third quarter, and commercial property values could tumble anew if companies renegotiate leases at lower rates. That's why the smart money is sticking with companies outside the real estate market, such as Johnson Electric Holdings Ltd., a maker of micromotors for appliances and power tools. Although its price-earnings ratio is 19 times expected 1999 earnings, the company has been a steady performer throughout the crisis, thanks to strong sales in Europe and the U.S. Elsewhere, politics could be the wild card in 1999. India's ruling Bharatiya Janata Party was trounced in state elections in December, weakening its coalition government. Besides the country's budget deficit and rising inflation rates, corporate earnings are under pressure. On average, Indian companies are selling for less than 10 times earnings, and the market as a whole is 35% below its average level of the past five years. So, India could become a buy if a new government begins reforms, while consumer stocks such as Hindustan Lever could benefit from consolidation in this sector. Economic reforms are also a major worry for investors in Latin America. Brazilian President Fernando Henrique Cardoso is locked in a pitched battle with Congress over an austerity plan he must enact if Brazil is to gain full access to a $41.5 billion IMF credit line. If legislators don't play ball, investors may rush for the exits, forcing the government either to devalue the real or defend it with depleted reserves. If Cardoso succeeds, however, investment opportunities could abound. Tudor Asset Management Managing Director Marcelo Borges already has both Banespa, a big bank, and Comgas, a major natural-gas distributor, in which the government plans to sell further stakes next year. Telesp, a fixed-line phone company, is a good defensive play if the economy is weak, says Morgan Stanley's Pelosky. Trouble in Brazil, of course, could easily spill over into other Latin markets, including Mexico. That risk is making Mexico's big, liquid stocks such as Telefonos de Mexico, a draw for investors wanting exposure in the region without getting locked in. Telmex sells at about 12 times expected 1998 earnings, less than two-thirds of that for AT&T. Analysts also like consumer stocks, such as Coca-Cola Femsa, the Coke producer. RISKY GAME. The biggest gamble of all, though, is Russia. Its finances are in ruins. Debt default in August and President Boris Yeltsin's fragile health have driven stocks down 86%, in dollar terms, in 1998. ''The probability of losing everything is high,'' admits William F. Browder, managing director of Hermitage Capital Management. But if you hang in, he insists, ''in two or three years, you'll have a 1,000% return.'' If those odds sound good, market watchers suggest oil company Surgutneftegaz. Once a Wall Street favorite, it has been through the wringer. It's now selling at a measly p-e ratio of 2.3, but it has little debt and owes no back taxes to Moscow--a rarity among its peers. If you're looking for calm to return to emerging markets in 1999, you're likely to be disappointed: They are going to remain choppy. The trick is to find the right stocks in which to ride out a storm that could still produce squalls for years.
By Brian Bremner in Tokyo, with Patti Kranz in Moscow, Elisabeth Malkin in Mexico City, and bureau reports RELATED ITEMS
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Updated Dec. 17, 1998 by bwwebmaster
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