Hot Returns South of the Border

Let's face it: America isn't the booming economy it once was. Those who haven't ventured beyond the U.S. markets have gained a mere 16% from the S&P 500 (SPY) over the past three years. The MSCI EAFE Index (EFA) has more than doubled that return, with 39% gains. Neither comes close, however, to the three-year returns of the MSCI Emerging Markets Index -- 102%! And that's an index.

Beyond the crippling of our housing market and high inflationary pressures, we've lost some of our power as a world leader. Global expansion is shifting to developing nations. Emerging countries now account for 30% of world GDP. Three of the five largest companies in the world are Chinese. Heck, PetroChina is arguably the most valuable company on the planet, according to The Economist.

Emerging markets move toward maturity
Historically, global market movements have been tied to the U.S. economy. That still holds true -- to an extent. For instance, just in the past year we've seen countless stocks that have little or no exposure to the U.S. drop erratically in response to our housing and credit problems.

However, our economy is becoming less important in the sustainability of these countries' long-term growth. As emerging markets develop, their population accumulates wealth, which allows them to rely less on exports to the United States to facilitate growth. Accordingly, as The Economist noted, China's exports to America have dropped to 24% of the country's total, down from 34% in 1999. In fact, many of these countries are relying on fellow emerging markets to fuel their growth.

Whether it's finding the next must-have item like Apple's (Nasdaq: AAPL  ) iPhone or finding the next exploding economy like India, migrating away from where the money currently is and discovering the next "hot" idea before it's "hot" is how great investors make their fortunes.

Many investors have just caught on to popular Chinese names such as China Telecom (NYSE: CHA  ) , China Eastern Airlines (NYSE: CEA  ) , and Ctrip.com (Nasdaq: CTRP  ) . But they're up big in the past year, and the best time to buy them may have already passed. It's time to forget China and discover the next emerging market.

Hola, South America
Right now, South America is where China and India were years ago.

While valuations look stretched, they're not as stretched as in Asia, and the region is loaded with some of the richest minerals in the world and improving macroeconomic stability. The region is progressing from its prior state of political weakness, high inflation, and economic crisis. And even after years of good returns, the South American market trades for about the same multiple as the larger emerging markets index.

Recovery in progress
Fundamentally, companies headquartered in South America have strengthened in recent years. Governments are more cash-rich, and as a result, many of these countries will attain investment-grade sovereign debt in the near future. These higher debt ratings effectively lower the cost of borrowing and thus allow these economies to invest at lower cost and grow at even higher rates.

South America's shaky history has left the region lagging in infrastructure. Investors should therefore look at companies that will benefit from the need to build telecommunication lines, transportation systems, and utility plants. This groundwork must be laid before other growth can occur.

Companies such as Brasil Telecom (NYSE: BTM  ) and CPFL Energia (NYSE: CPL  ) should produce fairly consistent and predictable cash flows going forward. The former services the continued demand for fixed-line telecommunications, while the latter provides distribution, generation, and commercialization of electricity throughout Brazil.

Don't just wish you could have had these returns
With its bubbling valuations, you may not still have time to get into China.

But fear not. You can avoid China's valuation risks and buy into an economy that is still in its early stages of development.

If China and India's past performance is any indication of what high-growth emerging markets can return to investors, you won't want to miss this opportunity. Need help getting started? Our Global Gains newsletter service scours the world for market-beating picks each month. Sign up for a free 30-day trial and you can see all of our picks and research and receive a special report about our team's recent research trip to -- you guessed it -- South America.

This article was first published Dec. 17, 2007. It has been updated.

Kristin Graham does not own any of the companies mentioned in this article and is a contributing analyst to Global Gains. Apple is a Stock Advisor recommendation. Ctrip has been selected by Hidden Gems. The Fool has a disclosure policy.


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