Economy engenders pessimism: if US economy stumbles, a perfect emerging market storm could develop.

It's the summer doldrums in the Mexican stock market and your regular columnist is on holiday so the editors have pressed me into service, flattering me and, hopefully, not deceiving you.

I have some very simple ideas about the Mexican market that can be summed up, as the risks seem to out-weigh the potential rewards after a 41 percent surge in the benchmark index so far this year.

If I had enough spare cash and the steely nerves to be investing in Mexican stocks I would be on the phone to my broker selling them instead of writing this piece.

Stocks have risen (as far as I can tell, the reasons are not always logical in the markets) because during the year investors have become more and more optimistic about the evolution of the Mexican economy and that of its main sponsor, the United States.

When looking at a broad market index, this is what usually drives the market. The Bank of Mexico does a useful monthly survey of private sector analysts' expectations and the latest for June shows an average prediction of 4 percent economic growth. Interestingly, this is the highest estimate for 2004 for more than two years. I always get nervous when everyone else is wildly optimistic.

High oil prices and an unexpected rebound in the US economy are driving the Mexican economy forward. These drivers, though, are external and Mexico is doing nothing to help itself.

The best-performing sectors of the economy are construction, fueled by the low-income housing boom and more oil export income for public projects and the maquiladora sector, which is driven by U.S. demand.

Inside the overall figures are a couple I like to look at because they give a fuller picture. In May the production of water, electricity and natural gas fell, indicating less demand from industry and consumers as a whole. And Petroleos Mexicanos, the state oil monopoly, sold less volume of refined products in May than it did in January.

This means demand for the basic inputs of the economy has fallen, which is not a sign of a robust country.

Coming back to the stock market, if my pessimism about the economy is on target this means that sooner or later the herd will shift direction and when it does the market will plummet.

There is another number that worries me. Foreign investment in Mexican stocks and bonds is up 15 percent this year, which means a lot of rookies are coming into the league and are likely to be nervous when facing the local curve balls.

These are likely to include a weakening of an overvalued peso at some stage and growing concern about lukewarm company profits. According to Deutsche/Ixe brokerage the number of earnings disappointments in the latest quarter is higher than three months ago, a leading indicator of future trouble. Add to this a volatile political situation and we could get a perfect emerging market storm that would send investors home in a flash.

And this is related to my final concern--the US economy. One of the reasons we have so many newcomers to the Mexican market are negative real interest rates in the United States as Alan Greenspan makes a final attempt to protect his legacy and reputation. All he has really done, together with George Bush's tax cuts, is delay the inevitable slump.

When this happens, apart from fritzing the Mexican economy, higher interest rates in the US will attract many investors home while driving up borrowing costs for Mexican companies and the downward spiral will begin.

Still, I am reliably informed that the US authorities will try to prop up the economy until the presidential election there in November, so no need to interrupt your broker's summer holiday. You probably still have a little time left.

And, of course, I could be completely wrong and President Vicente Fox could enact the structural reforms that would enable Mexico to become a competitive economy. Next month: the flying pigs phenomenon.

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Index                   30 June 2004     NOMINAL           REAL (1)
                                      Monthly  Accrued  Monthly  Accrued

Stock Market            INDEX
IPC                     10,281.82     2.5%     16.9%     2.3%     15.0%
INMEX                      583.56     2.8%     18.9%     2.6%     17.0%

Mutual Funds
Equity                   2,980.29     0.7%     11.8%     0.5%     10.0%
Debt for Individuals     4,194.06     0.2%      1.7%     0.1%      0.1%
Debt for Corporations    1,645.22     0.3%      2.1%     0.1%      0.4%

Economic Activity
Industrial               4,156.72     0.3%     22.9%     0.2%     20.9%
Retail                  14,745.42     1.5%     28.0%     1.3%     25.9%
Non-Financial Services   7,100.34     3.6%     11.7%     3.4%      9.9%
Insurance and Banks      4,630.87     0.0%     11.7%    -0.2%      9.9%
Broker Firms               414.03     0.0%      0.0%    -0.1%     -1.6%
Financial Groups           407.64     6.1%     21.9%     5.9%     19.9%

Sector
Mining                  10,918.40     1.9%      5.1%     1.8%      3.4%
Industrials              3,388.83     3.5%     15.0%     3.3%     13.1%
Construction            17,596.11     1.7%     20.2%     1.5%     18.3%
Retail                  17,218.16     0.7%     12.4%     0.6%     10.6%
Communications &        43,813.50     2.3%     19.3%     2.2%     17.4%
  Transportation
Services                 1,463.79     4.6%     32.7%     4.4%     30.6%
Holding Companies        3,620.96     3.3%     13.2%     3.1%     11.4%

Index                      DOLLARS (2)
                        Monthly  Accrued

Stock Market
IPC                     2.8%     15.1%
INMEX                   3.1%     17.1%

Mutual Funds
Equity                  1.0%     10.1%
Debt for Individuals    0.6%      0.2%
Debt for Corporations   0.6%      0.5%

Economic Activity
Industrial              0.7%     21.0%
Retail                  1.8%     26.0%
Non-Financial Services  3.9%     10.0%
Insurance and Banks     0.4%     10.0%
Broker Firms            0.4%     -1.5%
Financial Groups        6.5%     20.0%

Sector
Mining                  2.3%      3.5%
Industrials             3.9%     13.2%
Construction            2.0%     18.4%
Retail                  1.1%     10.6%
Communications &        2.7%     17.5%
  Transportation
Services                4.9%     30.6%
Holding Companies       3.6%     11.5%

(1) June inflation: 0.16% January-June inflation: 1.63%
(2) June depreciation: -0.3% January-June depreciation: 1.53%

Commentary by John Moody 

John Moody is a former reporter for Bloomberg News who has covered financial and political news in Mexico for nearly a decade. He can be reached at [e-mail].