MARKET BEAT TOM PETRUNO : Bolsa Booms Anticipating NAFTA Deal

Mexico’s stock market has roared back to life with the suddenly improved prospects for the North American Free Trade Agreement.

And while some investment pros wonder whether NAFTA’s benefits to the Mexican economy are overstated in the short-term, most agree that the treaty’s progress is crucial if Mexican stocks are to break out to new highs--which have proved elusive for the past 13 months.

On Friday, the 37-stock Bolsa index in Mexico City jumped 65.63 points, or 3.7%, to 1,844.52 on news that the United States, Mexico and Canada reached agreement on key side accords necessary for NAFTA to advance.

Though the treaty’s chances for approval this fall in Congress and the Canadian Parliament remain iffy, some analysts said the Mexican market’s reaction Friday provided a hint of what might unfold if passage begins to look certain.

“I would hate not to be in the Mexican market when a free-trade agreement is announced,” says Scott Galle, analyst at Santa Monica-based D.A. Campbell Co., a Mexican stock specialist.

NAFTA would create a single free market for goods and services in North America, eliminating over a 15-year period cross-border tariffs and taxes that now hinder trade.

Because Mexico has the lowest labor costs and least-developed economy of the three nations, it has the most to gain if capital can move freely across the continent in search of the greatest returns.

And if the Mexican economy benefits mightily from NAFTA, so too should many of its public companies and their stocks.

But Mexico-watchers are quick to warn that NAFTA is no automatic boon, anymore than the fall of the Berlin Wall was for Europe--now deep in recession.

The arrival of unfettered competition in Mexico’s young economy could hurt as many native companies as it helps. Mexican banks, for example, are considered vulnerable, as are some packaged food producers, such as bakery giant Grupo Bimbo.

Moreover, analysts note that NAFTA would be phased in, not take effect all at once. And in the near-term, Mexico’s economy faces some major structural problems that are unlikely to be fixed soon.

“I think people have concentrated too much on NAFTA and not enough on Mexico’s high real interest rates and an overvalued currency, which are hurting its companies,” says Jane Siebels, Mexican market analyst for the giant Templeton mutual fund firm in Fort Lauderdale, Fla.

Because Mexico already is so dependent on foreign financing for its economy--and because inflation remains a problem, at an annualized rate of about 8%--the government is forced to keep interest rates high to attract and keep capital. Investors in short-term (28-day) Mexican government debt now earn an annualized yield of about 14%.

Though rates have fallen from 20% last fall, they’re still high enough to be a drag on the country’s economy.

The Mexican peso, meanwhile, is supported by those interest rates, but also is arguably too high at 3.1 to the dollar. The government allows for a slow devaluation, but Siebels says many Mexican companies would like to see a fast 10% devaluation of the peso, which would make Mexican products cheaper for foreign buyers.

The problem is that there aren’t yet enough of those products (beyond oil, Mexico’s No. 1 export) to make a significant dent in the country’s worrisome trade deficit, analysts say. And the flip side of a currency devaluation is that it would cause foreigners’ capital to sink in value--hardly a constructive move for an investor-needy economy.

All these concerns have weighed on Mexican stocks over the past year, and the Bolsa index has been unable to top its all-time high of 1,907.36, reached on June 1, 1992--the culmination of a stunning run-up that began in 1988 with the index at a mere 100.

NAFTA, of course, would probably just increase Mexico’s dependence on foreign capital, at least initially. But investment pros who are most bullish on Mexican stocks believe that the market will quickly begin to reflect the long-term benefits of free trade: Bolstered by additional heavy investment, Mexico should gradually build a diverse export economy that generates self-sustaining wealth.

That should eventually bring interest rates down to levels competitive with the United States and Canada. And in the process, Mexican stocks’ price-to-earnings ratios also should begin to approach U.S. stocks’ P-Es, argues Paul Wargnier, Los Angeles-based manager of the $90-million Dean Witter/Trust Co. of the West Latin America stock mutual fund.

Indeed, the biggest argument in favor of Mexican stocks today is that they’re still very cheap, especially considering the double-digit earnings growth many Mexican companies are producing. By most accounts, Mexican stocks trade for an average price of 10 times estimated 1993 earnings per share. The U.S. market, in contrast, trades for about 18 times earnings.

Which Mexican companies have the most to gain from NAFTA? Some ideas from market pros:

* Cemex and Tolmex, two major cement producers. Faster economic growth will inevitably translate into more construction in Mexico, especially for single-family homes, says Jay Pelosky, Latin America strategist at brokerage Morgan Stanley & Co. in New York. And Cemex in particular has already shown it can compete with U.S. cement companies.

Wargnier, who also favors the cement companies, says Mexico needs to build 1 million new homes a year to house its booming population, but is putting up only 120,000 a year.

* DESC, a conglomerate that produces auto parts for export (a business expected to further mushroom under NAFTA), rubber, chemicals and poultry.

In an odd twist, Templeton’s Siebels says DESC is currently the victim of low-priced poultry “dumping” (specifically, dark meat) in Mexico by American firms, which face high demand for white meat in America but not much for dark. If NAFTA levels the playing field and thus halts illegal dumping, Siebels figures DESC would benefit.

* Situr, a real estate developer that owns resorts in Ixtapa and Puerto Vallarta, among other sites. Mexican resorts should not only attract more U.S. visitors as North American economies are integrated, but also more clientele from the growing Mexican middle class, Wargnier says.

What about Telmex, the Mexican phone monopoly and the country’s best-known stock? Many pros worry that although Telmex is a natural beneficiary of a rising economy, the stock already is so broadly owned here and in Mexico that it’s unlikely to lead a new Mexican bull market.

But Luis Maizel, principal at LM Capital Management in La Jolla, notes that Telmex could gain long-term as a new group of investors moves into Mexican stocks: Europeans and Japanese. “Once (NAFTA) passes, you’ll see a lot more confidence in Mexico” on the part of non-North American investors, Maizel contends.

Investors who want to own Mexican stocks directly can buy 22 issues in the United States in the form of American Depository Receipts, traded in dollars (mostly over-the-counter). Besides Telmex, Mexican shares trading here include Cemex, Tolmex, Situr, the shipping firm Transportacion Maritima and major retailers such as Cifra and Gigante.

A simpler option for most investors: mutual funds. There are three closed-end funds traded on the NYSE that own Mexican stocks exclusively--Mexico Fund, Emerging Mexico Fund and Mexico Equity & Income Fund.

But you will probably now have to pay a small premium in the funds’ share prices over the net asset value of the stocks they hold.

Also, there are six open-end funds that specialize in Latin American stocks generally. Most of these funds have large stakes in Mexico. Wargnier’s Dean Witter/TCW fund, for example, has 57% of its assets in Mexican stocks. Fidelity Investments (800-544- 8888) has a Latin America fund, as do the Scudder (800-225-2470) and G.T. Global (800-824-1580) fund groups.