WHAT YOU SHOULD DO ABOUT YOUR MEXICAN STOCKS AND FUNDS NOW
(FORTUNE Magazine) – If you were caught up in the Mexican growth story--and who wasn't?--you may have bought heavily into a mutual fund that put cash into the Mexican bolsa. Or if you're the independent sort, you bought a few thousand shares of Mexican stock yourself. Over the past four weeks, your Mexican investments have lost between 30% and 60% of their value. Welcome to emerging markets investing.
What should you do now? Barton Biggs, Morgan Stanley's chief investment strategist, is one of the few analysts encouraging investors to buy into Mexico now, on the age-old theory that investors should buy, not sell, during market turmoil. In a Morgan Stanley conference call on January 9, Biggs described the Mexican situation as "a classic selling panic" and predicted that it was almost over. "We'll have a short, sharp, steep rally," he argued. Biggs says some of the big Mexican issues will double or triple in that future rally. Most analysts, however, think recovery will be slower and uneven, and have adopted the more cautious stance that some Mexican industries might contain good buys, but only if you're willing to hang on for the long haul.
But first, ask yourself whether you have the stomach for more violent roller-coaster rides in the Mexican markets, because for a while that's what you'll get. If you don't, you should start unloading at least some of your holdings. Even if you do, and you have bank or construction stocks, you should strongly consider getting out; otherwise you'll likely face even greater losses.
Says Eduardo Cabrera, chief Latin American strategist for Merrill Lynch: "We suggest that people reduce their positions in Mexico. Right now we're underweighting the market [in our Latin American portfolio]. It's not like the U.S., where the market can drop but your chosen sector can do well. In these emerging markets, when the market turns down, just about everything goes down with it."
The International Finance Corp.'s Price Index shows that the bolsa average at the end of December was 1582.48, down 860 points, or 35% in U.S. dollar value, from November's 2442.48 average. In the first two weeks of January, the bolsa lost another 15%. Mexican Brady bonds have also been drummed. The bonds, created out of defaulted sovereign debt under guidelines set by former Treasury Secretary Nicholas Brady, are trading at about $540 per $1,000 of face value and yielding 15.81%. Right after NAFTA passed in November 1993, the bonds hit a high of $830. J.P. Morgan's Mexican Brady Bond Index is down 13% since the Mexican government let the peso float against the dollar, and instead of floating, it sank some 40%.
Cabrera and other Mexico watchers note that selling has been so furious that the Mexican equities market is probably underpriced. But that is a difficult call in light of the volatility of the market indicators. And even if the market is undervalued, that doesn't mean it won't go lower. Many of the leveraged investors in Mexican securities are still unwinding their positions, which will push the market further south.
In addition, American mutual funds with big investments in Mexico have not yet been hit with heavy redemptions, so their managers have been slow in selling to raise cash. Most of these funds are down 30% or more since mid-December, and when the 1994 fund statements reach investors at the end of January, redemptions could suddenly pick up along with the need to dump Mexican issues for cash. Meanwhile these mutual funds are driving down other Latin markets by taking profits in Brazil, Argentina, and elsewhere.
In the long run the Mexican economy still has much to recommend it, but the government's moves to quell the crisis will shrink the economy to about 1% growth or less from the 4% it had earlier forecast. (For more on Mexico's economic outlook, see Global.) Some very dark clouds loom overhead just now. The biggest is the instability of the peso. Until it stabilizes, no one can make reasonable judgments about corporate earnings, stock prices, interest rates, or the inflation rate. Another is the government's massive short-term debt. How will the government pay off the more than $10 billion of Tesobonos--short--term Treasury bills-that come due in this year's first quarter? Watch Tesobonos closely for signs of a deepening crisis or a resolution. If the government can solve the problem without more blunders, that could restore some foreign investor confidence in Mexico and even ignite a stock market rally.
An industry that is well insulated from the current trouble is mining. The international market determines the value of its products, denominated in dollars. But workers in this labor-intensive industry are paid in pesos. So even with a slight wage increase, the Mexican mining industry should benefit from the devalued peso. Silver-mining giant Industrias Penoles has seen its stock price rise 55% since the beginning of the year. San Luis, a mining and auto parts conglomerate, has seen a 45% increase over the same period.
The problem with the mining stocks is that investors immediately recognized them as a hedge against currency risks and quickly bid them up. Now, says Juan-Carlos Garcia, an emerging markets analyst at Salomon Brothers, the mining stocks are just about fully priced. So you won't find bargains there, but if they're in your portfolio, hold on to them.
Like mining, tourism has the benefit of getting its income mostly in dollars, while most of its operating costs are in pesos. Among hotel- and tourism-related companies, Salomon recommends Situr, a property developer with a large portfolio of tourist hotels, and Posadas, the country's largest hotel management company.
Another sector Salomon likes is beverages. Soda is a staple in the Mexican diet and one of the largest sources of calories. Even with the expected decline in consumer spending, Salomon estimates that per capita consumption will drop less than 3%. Soft drink companies like Coca-Cola Femsa, Gemex, and PanAmerican Beverage should be able to sustain revenues. Two of them could actually have increases in both sales and profits. Coca-Cola Femsa has added a new territory to its distribution system, and Gemex recently increased production capacity. The food sector is also a good defensive play.
The outlook for the telecommunications sector, dominated by Telafonos de Maxico (Telmex), is more complicated. The government has just opened the telephone industry to foreign competition, and while Telmex maintains high margins, its monopoly will soon disappear. Earnings growth will likely slow. Telmex ADRs, often the most active issue on the New York Stock Exchange, recently sank to a new low of $33.365. Last year's high: $76.125. J.P. Morgan analysts recently downgraded Telmex from a "strong buy" to a "market performer," meaning they don't expect it to outperform the bolsa.
Banking and construction are the two sectors that most analysts warn investors to avoid because both will be badly hurt by the slowing economy, higher interest rates, and reduced government spending. Mexican banks face obvious trouble as corporate borrowers encounter problems making payments or simply default. Fourth-quarter bank earnings will probably be lower because banks' equity is in pesos and their debt in U.S. dollars.
The banks' problems mean even more difficulties for Mexico's corporate sector. The country's latest crisis will make raising financing abroad more difficult and expensive for big companies, which will have only local bank credit lines to fall back on. Now even those will be more tenuous.
The construction industry, which has benefited from government spending on infrastructure and in turn has been driving much of the economy's growth, will see an almost immediate falloff in business. With the drop in construction, demand for construction materials, especially cement, is likely to plummet. That does not bode well for Cemex, the giant cement company with holdings in Spain and other parts of Latin America, or Tolmex, Cemex's main Mexican subsidiary. Both trade on the bolsa, and both stocks have been clobbered. Cemex is down 17%, and Tolmex is down 27% since devaluation.
PLAYING THE WOOFIE CARD
Investors with an eye on the future can find rich opportunity in the growing numbers of "woofies," or well-off old folks, defined as people over 50 with money to spend. Between now and 2005, an average of 4,400 Americans will turn 50 every day. Even the baby-boomers are getting there. Next year the eldest of the 78 million boomers will enter their sixth decade. The trick is to pick stocks that will get a lift from the leisurely pastimes of affluent people who have arrived at a time in life when it is okay to enjoy some of their hard-earned cash.
Recreational vehicle makers like Winnebago Industries and Monaco Coach are sure to benefit because RVs have always been popular with older people. The 45 to 64 age group that Winnebago targets is expected to grow 33% this decade. The company had $450 million in sales last year from a product line that ranges from low-end campers to plush walk-throughs like the $150,000 Luxor model.
But Winnebago isn't just sitting back waiting for woofies, and those about to become woofies, to walk into dealerships. The company is improving quality and adding features to its motor homes, like a hydraulic room extension system on one model to make the vehicle roomier when parked. Frank Rolfes at Dain Bosworth expects Winnebago's earnings to increase 15% annually for the next three to five years and the stock, now $10, to reach $14 in a year.
Monaco, with an estimated $100 million in sales last year, is the biggest high-end producer of motor homes. Woofies are about the only people who have the time or money to tool around in these vehicles, which start at $100,000. A big part of Monaco's sales come from repeat buyers who purchase an entry-level model, become enthusiasts participating in Monaco rallies, and trade up. The top-of-the-line Signature sells for more than $300,000. Rick Fradin at William Blair estimates earnings will rise 18% this year and that the $15 stock will appreciate accordingly.
Woofies aren't just cruising the roads; they're increasingly on the high seas as well. Paul Mackey at Dean Witter Reynolds likes Carnival Cruise and Royal Caribbean Cruises. Says he: "When you get into the sixth, seventh, and eighth decades, with the kids through school and the house paid for, you are at an age when you are not going skiing or hang-gliding. Cruising is very appealing." Some 5.5 million people will take cruises in 1995, an 11% increase over last year, while net new berths will increase only 3%. That kind of demand has Mackey comparing cruising to a field of dreams: If you build a ship, they will come.
Carnival operates two major lines, the moderately priced Carnival Cruise Lines and Holland America, a premium line mostly plying Alaskan waters. Carnival, based in Miami, is increasing berths by 50% at both lines over the next three years. The expansion will help boost earnings nearly 18% this year. Mackey thinks the stock, selling at $21, or 13.1 times his 1995 earnings estimate, could be at least $25 in a year.
The case for Royal Caribbean, the first line to build ships specifically for warm-weather cruising, is much the same. The company has ordered six ships, which will increase capacity 72% over the next four years. With $1.1 billion in revenue last year, Royal, also in Miami, is the leading Caribbean cruise line, operating nine ships with more than 14,200 berths, 17% of the industry's North American capacity. Royal's stock is $27, 10.8 times Mackey's 1995 earnings estimate. His target price is $36.
Another stock that should ride with the woofies is Brunswick, a maker of powerboats, outboard motors, and fishing, bowling, and billiards equipment. Boating, fishing, and bowling have always been popular with older people and should continue to be. The company, which had estimated 1994 revenues of $2.7 billion, is leading the marine industry recovery. Jill Krutick at Smith Barney thinks earnings will increase 20% annually over the next five years. She thinks the $19 stock could be in the mid-20s in a year. While playing the woofie card, investors get a bonus: Bowling has become a fast-growing sport in Asia.
- John Wyatt
TIPTOEING INTO TREASURIES
KISS--Keep it simple, stupid. No offense, but that's the strategy that will best serve fixed-income investors trying to put a disastrous 1994 behind them. For the risk averse, that means sticking to plain old treasuries. Why? Take a look at the treacherous markets out there. Sure, munis are cheap, but is another Orange County waiting to implode? High-grade corporates offer less than one point more yield than Treasuries. And with the economy expanding for the 46th month, the prospect that junk bonds will face a contraction--and credit downgrades--is growing. Says Oppenheimer chief investment strategist Michael Metz: "Sometimes the simplest solution is the best."
The good news is that simple Uncle Sam is looking generous indeed. Look at the higher yields that bond investors paid so dearly for last year: The 30-year long bond yields 7.8%, and even the lowly six-month T-bill pays 6.5%. With the consumer price index rising less than 3% a year, inflation-adjusted returns are far higher than in recent years.
The best advice for buy-and-hold investors? Keep it short, as well as simple, primarily in two- and three-year notes. These yield 7.6% and 7.7%, respectively, or 96% and 98% of what the long bond is offering with just a fraction of the interest rate risk. But the payout is far better than issues just a couple of rungs down the maturity ladder: the six-month T-bill is throwing off 83% of what the 30-year bond yields. Jeffrey Tyler of the Benham Group in Mountain View, California, cites an Arbor Trading Group study showing that in the year following a bond market rout-and 1994 was the worst since 1927--short-term bonds outperform long-term ones. Says money manager Gerald Thunelius of Dreyfus: "The two- to three-year bonds are perfect for buy-and-hold investors to tuck away." But don't bet the farm. With the economy galloping ahead, Greenspan & Co. are likely to jack up short-term rates, producing paper losses for short-term investors. Says Tyler: "You can't get worse than 1994, but 1995 is still a time for caution."
Investors who want to venture further out in maturities could benefit from the professional management of funds in this environment. Some expect today's yield curve to invert, with shorter-term rates rising higher than long-term ones as the Federal Reserve tightens and the economy begins to slow. Says manager Bill Hutchinson of the Scudder Income fund: "There will be times in the next 12 months when long-term rates drop, and I'm willing to wait for that and hopefully lock in some capital gains." He is blending 30-year bonds with T-bills to produce an average portfolio duration of five years, a barbell approach that can boost returns while dampening risk. It's an elegant strategy, but one probably too complicated for many individual investors.
Should bond fund investors fret about losing principal in the face of yet another rate run-up? Not unduly. Brokerage Sanford C. Bernstein estimates that by sticking with a short- or intermediate-term fund in the face of a selloff, investors can shortly recoup any losses by virtue of the accompanying higher rates--provided they resist the temptation to flee. The cash is not always greener at the other end of the maturity ladder. Adds Dreyfus's Thunelius: "Too many people have gotten into the mind frame of bottom fishing and getting out quick." In today's volatile market, that's risky.
- Richard S. Teitelbaum