Does Mexico's Stock Market Have the Flu, Too?

Investors have long sought high risk/high reward opportunities in emerging markets and Mexico has been no exception. As a major U.S. trading partner rich in energy, raw materials and relatively cheap labor, the republic to the south has many allures. But as pestilence, violence and now a new natural disaster attests, investing in Mexico is also fraught with uncertainty.

Global markets were rocked Monday on news that swine flu is spreading around the globe. It's thought to have started in Mexico and so the country is locking itself down and investors are fleeing its equities. It's the last thing any country, or its market, needs. As if that weren't enough, the flu outbreak comes hard on the heels of escalating warfare among rival Mexican drug gangs.

And just when investors thought it couldn't get any worse a powerful 6.0 earthquake struck 50 miles outside the capital, sending office workers scrambling into the streets.

This trifecta of rotten luck has to have investors in Mexican stocks rethinking their positions. Is the country just star-crossed — or is this a rare buying opportunity for an aggressive emerging market portfolio? If you listen to the experts — and have a little money to risk — the answer may be the latter scenario.

The selloff just might be creating some bargains, if only because of Monday's indiscriminate selling. The iShares MSCI Mexico (EWW) exchange-traded fund fell sharply, hurt partly by a steep selloff in shares of Wal-Mart de Mexico (WMMVY). Although it makes sense that a retailer's sales could be hurt by flu fears, that reasoning doesn’t really translate to most other big Mexican stocks. For example, 40% of iShares Mexico's holdings are telecommunications and media companies like America Movil (AMX). If anything, those types of services should benefit from folks sequestering themselves off from one another.

David Riedel, head of emerging markets investment firm Riedel Reseach, says the headlines will cause at least short-term volatility in some other sectors, too. Alsea, the franchisor for Starbucks (SBUX) and Burger King (BKC), took about an 8% hit Monday. Oil also lost over $1.50 a barrel. “It remains to be seen how long some of this will last,” he says. “If it stays confined to Mexico City and the area nearby, I think it will be a small blip."

Even Reidel admits that’s a big if. However, there are ways to take advantage of the situation without making a big bet on a single country fund like the iShares product. Indeed, Bill Rocco, Morningstar’s emerging markets funds analyst, says the epidemic and the subsequent selloff should underscore the value of a diversified portfolio.

"It's a reminder of why you don't want to focus on a particular emerging market,” he said. “Mexico is the second-largest market in Latin America, but you shouldn't be in just a Mexico fund, or even a Latin American fund. You'll do better to have exposure to 40 individual markets through a diversified emerging markets fund."

One way to bet on Mexico while shedding some risk is to buy T. Rowe Price Latin America (PRLAX), a top-rated fund that has returned an average annual 20.8% over the last five years, good enough for the top spot in its Morningstar category. Those returns were primarily primed by a 64% weighting in Brazil, including a large position in oil company Petrobras (PBR). The fund also has exposure to Mexico (22%), Chile (4%) and Peru (4%).

Another option is the Vanguard Emerging Markets Stock fund (VEIEX). The index offering owns nearly 800 companies spread out in over two dozen emerging markets. It has a 5% stake in Mexico and has positions in South American countries, too. It has returned an average annual 7.8% over the last decade, and charges a 0.32% expense ratio. That’s one of the cheapest fees you'll find in the space.