Stalking a Tiger

Investors wagering on developing markets in Thailand, Brazil, China, Russia and other far-flung lands have been underwater a long time. A $1,000 investment in an average emerging-markets stock fund in June 1994 would be worth about $900 today. Maybe they should be called submerging markets. This year, though, the world's economic trouble spots have come up for air--and suddenly we have the re-emerging markets.

Call them what you will. The name game simply underscores the up-and-down nature of funds that invest in developing regions. Risk has rewards: emerging-markets funds are up an average of 32% this year, beating the Standard & Poor's 500 by a factor of three. No broad area of stock investing has paid off bigger in the first half of 1999.

What's behind this off-off-Broadway revival? Emerging-markets stocks were driven absurdly low by the global selling panic that climaxed last fall. Since then, there's been a growing sense that the turmoil has ended. For the first time in nearly a year, U.S. investors are buying more shares of emerging-markets stock funds than they are selling. But if you're part of that wave and are simply chasing funds with momentum, look out. Trouble lurks. The mo may shift soon. If you're building a permanent long-term emerging-markets position, though, now is a fair time to get started. Just don't overdo it. These stocks should be only 5% to 10% of your portfolio.

Why own them at all? They've been down a long time, and if the economies of emerging nations take flight those nations' companies--potentially among the fastest growing on the planet--will soar in value. Even though the long malaise in Japan illustrates that an economy can take decades to snap back, odds are that emerging nations will recover in the next few years. To reap the spoils, you'll need to be there before the recovery is obvious. Take note: the fast money has already been made. This year's rally is the result of money flowing in from investors who long ago recognized that the worst of the global crisis was over. If that's your premise, don't bother. You're late. To buy emerging markets now you must believe in imminent and sustainable growth.

That's the dicey part. Economic turmoil could resurface for any number of reasons. Rising interest rates in the U.S. could slow American demand for goods produced in emerging nations, stifling the recovery. And Asia could collapse again on its own, perhaps misreading this year's higher stock prices as a sign of economic health when the buoyant markets really are just the result of bargain hunting by a lot of speculators. Already there is evidence that Thailand, the first Asian domino to fall two years ago, is ready to declare victory and backpedal on key promised banking and other reforms. If the speculators lose faith, they will take their profits and run, and emerging markets will sink again.

The stocks are also likely to sink if the U.S. market falls. Long term, they make a lot of sense. Barton Biggs, emerging-markets guru at Morgan Stanley Dean Witter, predicts that "coming out of the next cyclical bear market," whenever that may be, "emerging markets are going to be the place of maximum outperformance." Even if he's right, you've got plenty of time.

See time.com/personal for more on stock funds. E-mail Dan at kadlec@time.com See him on CNNfn Tuesday at 12:45 p.m. E.T.