OUTLOOK : Investors should look ahead to a tequila sunrise

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The Independent Online
Some of the most successful stock market investors have been lateral or contrary thinkers. Do the opposite of what everybody else does and you cannot fail, has over the years proved as reliable a stock market strategy as any. Not many have heeded the advice in the scramble for emerging market investments, however. The result is embarrassment and pain.

"We are looking for the first opportunity to sell everything we've got there," one emerging market investor confessed yesterday. It is a natural reaction when many Latin American funds have lost 20 per cent of their value in the past month. Some very recent launches have done even worse. It is an overreaction, though. Even if the Mexican stock market continues downwards, the currency is likely to have a post-crisis bounce in a few weeks. If the emerging market funds intend to bail out of Mexico, that isthe time to do it. That will be the time to get funds out of the country.

The real lesson of the Mexican fiasco is - yet again - the danger of piling into emerging markets along with the rest of the investing crowd. Net foreign capital inflows into Mexico probably reached $70bn during the past three years. It is one of those sad facts of investment life that markets become most fashionable with investors just as they are reaching their peak. Stories of Eldorado returns have prompted a lemming-like rush towards the precipice. The marketing men have had a field day.

Those now trying to beat a hasty retreat are discovering that there is no safety in numbers. In fact, the sheep-like stampede is making the problem worse by herding the peso down to unjustified levels. One of the things that made Mexico so attractive to emerging market funds is that it was thought to be currency risk-free. No fixed exchange rate system can survive determined market forces, however, and Mexico's exchange rate proved unsustainable. Mexico has become a mirror image of our own exchange ratemechanism crisis, only in Mexico's case it was not recession but boom that provided the selling pressure. Mexico has been sucking in imports like there is no tomorrow.

The flock of investors is now heading straight for the next pitfall - selling out of other Latin American markets, as if economic problems, like rabies, crossed national borders. Foreign investors seem to have been trying to realise Latin American profits whereever they can. Since other Latin American markets have been falling in sympathy, it seems a not unreasonable strategy.

In at least one other case, Argentina, there are strong parallels with Mexico. Argentina's currency is overvalued and the country carries a massive trade deficit. Like John Major and Norman Lamont, its ministers of state say they will never devalue. Worthless words. There will be an Argentinian currency crisis in due course without a doubt.

Other markets in the region, including Brazil and Chile, however, still look reasonable bets. The economies are sound, stock market prospects good, and currencies reasonably valued. Venezuela has actually been the best-performing emerging market in the world in the past month, after collapsing in an untidy heap at one stage last year.

Piling out of Latin America because of events in Mexico is as dim-witted as piling in in the first place. Fund managers in Britain and America have been investing in emerging markets long enough to have learnt that these are highly volatile beasts. Even those countries with pretensions to sophistication, like Mexico because of its relationship with Uncle Sam, react to events with melodramatic excess.

It seems many professional fund managers need some simple lessons in investment strategy. The value of assets can go down as well as up. It is a mistake to put too much of your portfolio into one market. The time to sell is when a market has gone up, notwhen it has crashed.

Likewise, the time to buy is right after a crash. If past experience in emerging markets holds good, Mexico will turn out to be one of the best performers in 1995. This is not an unduly bold prediction, as even a 50 per cent advance will not recoup all the recent losses. Time for a tequila sunrise?

Action needed now on electricity prices Prices in the electricity trading pool have hit the headlines once again, lending weight to longstanding complaints by a number of very large companies that they pay way over the odds for power. The blips in price at the moment are spectacular at around 45p per unit in some half-hour periods, compared with an average of about 7p per unit in a day. Even though the regulator has insisted that the pool price averages no more than 2.4p a unit, over the year as a wholesome big industrial users are suffering.

The pool is a complicated and difficult system. In essence it works like this. Each generating company states what its various power stations are going to charge for various half-hour periods of the day, thus establishing a market price. When the temperature drops, demand picks up, and prices rise. There are also signs that industry, recovering from recession, needs more power. The immediate problem has been caused by a coincidence of this natural increase in demand with the temporary loss of two large nuclear power stations from the system because of problems with welds. This has taken out one fifth of the nuclear capacity. Nuclear in turn accounts for almost a quarter of electricity production in England and Wales.

The loss of nuclear capacity means that PowerGen and National Power are filling the gap with plants that would normally run infrequently and that are much more expensive than "base load" nuclear, which runs just about all the time. A peculiarity of this supposed market is that the last plant chosen by the generators to state its price determines the price for the pool as a whole. All fiendishly complicated. The result, however, is very simple: the generators rake it in.

National Power and PowerGen argue that fundamentally the system is fair since the sort of plants they are presently being forced to use to meet demand are expensive to run - at least one in use at present has not been on the system for over a year. It also seems reasonable to pay the generators something to keep open excess capacity.

Furthermore, the average elecricity consumer is protected from all this volatility because the regional electricity supply companies take out contracts with the generator to hedge against the blips in the pool. Many companies also take out this type of contract and are similarly protected. For most people, then, the pool is about as relevant as a ten bob note. There are, however, a number of large electricity users, notably ICI, which have chosen to play the pool.

Professor Stephen Littlechild, the director-general of Offer, already believes that National Power and PowerGen have too much market power - hence the pool price cap until March 1996. He has also demanded that the generators sell off plants by the end ofthis year to facilitate competition. Eventually such action might do the trick. In the meantime some interim measures are clearly required to prevent abuse.

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