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The Nasty Side of Global Market Investing

Whether or not market interdependence continues, price volatility is here to stay

THIS year is beginning to border on a nightmare for international money managers. Dozens of them, armed with ``hedge funds,'' have lost hundreds of millions of dollars in a matter of hours in markets at one end of the world or another.

Country after country has seen interest rates jump upward as foreign investors scramble to sell bonds, which has then hit stock markets virtually across the board. International fund managers found no monetary shelter to hide in as they tried to sell. As a result, losses have mounted.

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It all started in the United States with the Federal Reserve nudging up short-term interest rates on Feb. 4 by one-quarter of a percent. The bond market reacted so nervously that now, six weeks later, the 30-year Treasury bond yield has risen three-quarters of a percent.

But what was completely unexpected was the degree to which the markets have become interdependent, regardless of whether they are tied to economies that are growing or that remain in recession.

For example, thus far in 1994, 10-year interest rates in Britain have risen 1.08 percent. In Germany they rose 0.68 percent. In France, 0.58 percent. And in Japan, 0.93 percent.

Making matters worse, as interest rates have risen, stock market prices have gone in the opposite direction. The London Stock Exchange is down 5 percent. The German DAX dropped almost 7 percent. The French exchange is down 3 percent.

In fact, overseas losses have generally exceeded those occurring in the US. Paradoxically, Tokyo has proven the exception to the rule; Japan's market is up 12 percent this year despite higher interest rates.

Looking more closely at this picture, last year's favorite investment vehicle - emerging markets - has also suffered. As US interest rates rose, prices on the bonds of developing countries (particularly those in Latin America) rose sharply.

Over the last few years, banks, and later fund managers, have done very well buying the debt instruments of the governments of Latin America as their credit ratings have been restored.

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Investors have been looking for higher yields than on US Treasury bonds and so found this paper more and more attractive. They brought in massive quantities that pushed down yields.

Recently, this cycle has gone into reverse, with nervousness in the US bond market having a kind of multiplier effect on these bonds. For example, Mexican government ``par'' bonds have fallen from 84 at the beginning of the year to 73. Argentine pars went from 69 to 59, and Venezuelan from 74 to 60.

Just as in the industrial world, the stock markets in developing countries have been hit with Hong Kong down 17 percent, Malaysia 18 percent, and Thailand 22 percent. Latin American markets have fared better, although rapidly rising US interest rates have had an effect except for in Brazil, which is up almost 40 percent this year and Chile 16 percent.

This is very different from what was supposed to happen. The concept of ``global'' money and capital markets was that a wider and wider array of countries and corporations could raise debt and equity by accessing these markets. By using derivative techniques, it became possible to raise money in one market and immediately change the currency or interest rate derivatives of the transaction to suit the needs of the issuer. From the fund manager's point of view, the theory was that portfolio returns would be increased by taking advantage of different markets and economic cycles - whether by buying European bonds, or equities in developing countries.

THUS, ``global'' investing was viewed as akin to looking at a wide canvas of investment opportunities and then taking advantage of market diversification to reduce risk and increase profits. This is why US mutual funds tripled their exposure to international markets in the last year or two, and why hedge fund managers were so captured by the idea of globalization that they leveraged up their holdings by borrowing heavily from banks. Markets were supposed to act independently; there was no reason why, if interest rates rose in the US, they should not fall in Germany or in Mexico.

Sadly, the markets have not worked in this predictable fashion in 1994. That makes it particularly difficult for many fund managers, who achieved massive returns in 1993 and quickly became international gurus.

What seems to have happened is that many international fund managers and traders have sold assets in all markets in an attempt to recoup losses in one market by trying to take profits in others.

Once this gathered momentum, nervousness set in, leading to panic selling - with few willing to buy. Liquidity has evaporated and prices have fallen farther and faster than anyone thought possible, leaving the old theory of global investing in tatters.

The question is whether global market interdependence is now a lasting feature of the international markets such that problems in one market quickly transfer to others. The alternative view is that 1994 will turn out to be a painful learning experience, and fund managers will go back to treating markets separately.

What is certain is that price volatility will be a continued feature of global investing. This is likely to limit any possible fall in interest rates, even when conditions settle down again. The Opinion/Essay Page welcomes manuscripts. Authors of articles will be notified by telephone. Authors of articles not accepted will be notified by postcard. Send manuscripts by mail to Opinions/Essays, One Norway Street, Boston, MA 02115, by fax to 617 -450-2317, or by Internet E-mail to OPED@RACHEL.CSPS.COM.

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