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Latin America Storms Higher, But Doubts Remain

Latin American funds have been outstanding performers this year, but let's not break out the piatas just yet.

There has been plenty of news to cheer about south of the border in the first seven months of 2003, as political stability and improving economic fundamentals have brought new money into the tumultuous region following a disastrous 2002. The average Latin American equity fund has produced a 23.2% return so far this year, according to Lipper. In the one-year period ending July 31, they've posted a whopping 32.4% gain.

The rally in Latin American stocks has been somewhat narrowly led. Pockets of strength have come from the telecommunications, wireless, retail trade and oil groups, and mutual funds investing in the region are known for placing huge bets on a handful of companies. Leading the pack has been blue-chip America Movil S.A., which has skyrocketed nearly 54% this year, as reported by Baseline. Brazil Telecom, the nation's third-largest fixed-line carrier, was also attracting plenty of interest, advancing 36% year-to-date. Oil refinery Ultrapar Participacoes S.A. is up 38% year-to-date. Home improvement outlet Wal-Mart de Mexico has put together a winning streak of its own, jumping 25%.

But over the long haul, the numbers are much less impressive, with the average Latin American fund generating a meager 2.23% return over the last five years - on par with the yield on a money market fund. Historically, the region has been plagued by significant volatility, high levels of debt and political unrest. That trend is best illustrated by the collapse of the Argentine economy after it stopped payments on $144 billion in debt, marking the biggest default in history. However, the impact of its enormous debt, devalued currency and overall economic depression has not stretched beyond its borders.

In fact, Brazil has made significant strides since President Luiz Inacio Lula da Silva took the reins in January. His administration is currently working to pass a pension reform bill that would raise the retirement age of public workers, reduce the pension benefits of future public employees and tax the pensions of retired public workers.

The pension reform, which has received initial approval in the lower house of Brazil's Congress, aims to reduce the system's annual 5% drain on Brazil's gross domestic product. da Silva hopes to pass the pension reform and retool Brazil's tax system before focusing on promises to create jobs and tackle poverty. The restructuring plan, combined with a U.S. stock market rally has stirred optimism, throughout Latin America. "That's going to save the Brazilian government a lot of money," said Tom Roseen, a research analyst at Lipper in New York. Indeed, The Sao Paulo Stock Exchange's benchmark Bovespa index is up 21% year-to-date.

Still, a number of obstacles still exist. Roseen said that farmers in Brazil who initially backed da Silva in the election are fighting over land as they continue to push for some sort of agrarian reform.

Earlier this month, the Economic Commission of Latin America and the Caribbean (ECLAC), a division of the United Nations headquartered in Santiago, Chile, forecasted a modest recovery in Latin America, estimating the region's economy will grow 1.5% this year, up from a 0.6% decline last year. That was less than the original forecast of 2.1% growth in January.

"The external engine is absent," an ECLAC spokesman said. "The United States is not growing as forecast, the European countries have turned in a surprisingly poor performance, and Japan remains stagnant."

The Latin American economies posting the strongest export performance are those with the most competitive exchange rates or those concentrating investments in non-renewable natural resources, the report said. Tax reforms, expansionary monetary policies and calmer foreign exchange policies are emerging as the most significant trends in terms of economic policy.

"Moderate GDP growth may be enough to hang your hat on provided that they get the support from the U.S. economy, Roseen said. "They need support from corporations and evidence that the top of the food chain is going to start working."

He added that while the returns look phenomenal over a one-year period, he still thinks there is a lot of volatility left in Latin America and that investors should proceed with caution. If a rampup in capex spending doesn't materialize, then we could flip back to negative returns, he said. Unemployment also remains a major problem in Brazil and Mexico, the region's two biggest economies. In all of Latin America, the number of people without a job is expected to reach 13.6 million in 2003.

Meanwhile, Latin America's local mutual funds posted strong net inflows in June bringing total assets under management to $187.17 billion, up from $152.67 billion at the end of March and $140.78 billion at the end of 2002, according to a report from Thomson Financial Brasil.

"If the second half of this year resembles the first half, you will see assets under management exceed $200 billion by the end of the year," said Guillermo Mazzoni, director of research at Thomson's Brazil office. However, 45.5% of that increase was fueled by rallies in local currencies against the dollar. New cash being put to work made up only 26.5% of the total.

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