Global Cooling in the Markets

Foreign stock markets, which have attracted billions of dollars from American investors over the last two years amid dramatic gains, suffered a wrenching sell-off Monday on deepening worries about the global economy.

Russian stocks plummeted 9% -- the equivalent of the Dow Jones industrial average diving 1,000 points. Brazil’s main market index slid 3.3%.

In India, the market sank 10% before trading was suspended for an hour. Authorities said they feared suicides by Indian brokers and their customers, some of whom had gone into debt to buy stocks as they rocketed.

Many analysts cautioned against panic, noting that smaller foreign markets were prone to wild swings. Even so, major European markets also were hit hard Monday.

The losses are certain to be felt by U.S. individual investors, who pumped a net $105 billion into foreign stock mutual funds last year, more than three times their net new investment in U.S. stock funds, according to the fund industry’s trade group. Much of that cash was invested through 401(k) plans and other retirement programs.

The selling wave Monday, which slammed shares on every continent, also weighed on the U.S. market. Wall Street’s decline was relatively modest, however. The Dow index eased 18.73 points, or 0.2%, to 11,125.33.

The worldwide downdraft in stocks started with U.S. markets on May 11, a day after the Federal Reserve raised its key short-term interest rate for the 16th time in two years and disappointed investors by signaling that it might continue to tighten credit to curb inflation. The Dow has lost more than 500 points over the last eight trading days on fears that higher rates will derail the economy.

The U.S. market sell-off spread overseas on concerns that rising rates could choke off U.S. consumer spending and trigger a global recession, analysts said.

“If interest rates keep going up and we have a steep falloff in U.S. consumption, one question is how the global economy would handle that,” said Mark Headley, president of Matthews International Capital Management in San Francisco, which has about $7 billion invested in Asian stocks.

“That’s on every Asian executive’s mind and on every Asian stock investor’s mind,” he said.

Another fear is that higher interest rates on relatively risk-free investments, such as bank savings certificates, could attract investors who otherwise might pour cash into stocks.

Foreign stock markets, particularly those of so-called emerging nations, have benefited as investors put safety concerns aside in the search for more lucrative returns on their money over the last few years.

Boosted in part by foreign money, the Mumbai Stock Exchange’s index of 30 major Indian companies zoomed 178% in the three years ended Dec. 31. It tacked on an additional 34% through May 10 of this year.

In those same periods, the U.S. Dow index was up 28% and 9%, respectively.

“Pretty much all of these emerging markets got pushed up beyond where you would expect, because there has been so much money out there with nowhere else to go,” said Cameron Brandt, head of research at EmergingPortfolio.com in Cambridge, Mass., which tracks investment in foreign markets.

Americans who rode the bull markets in emerging economies such as India, Brazil, Russia and Turkey were joined by local investors, many of whom were thrilled by a surge in share prices on par with the performance of U.S. technology stocks in the late 1990s.

Strong fundamentals had underpinned the emerging-markets rally, experts say. One was that stocks of many smaller countries had languished while U.S. stocks soared in the 1990s, so the foreign issues were relatively cheap as the decade began.

What’s more, China’s economic boom began to lift prices of raw materials such as oil, copper and nickel about three years ago. That delivered a windfall to many emerging nations that export those commodities, strengthening their economies and generating local wealth that partly flowed into stock markets.

In India, economic deregulation and an expanding technology-service sector have spurred economic growth and empowered millions of new investors, analysts say.

As occurred during the U.S. bull market of the 1990s, the lure of fast gains encouraged some investors in emerging nations to borrow to buy stocks in recent years. As share prices fall, the brokerages that lent investors money often call in the loans, triggering more selling as investors rush to raise capital to pay their debts.

That was a factor in Monday’s losses.

“I borrowed money to trade in the market. I lost it all in the past two days,” 37-year-old Sanjay Joshi, a small investor in the western Indian city of Ahmedabad, told the Reuters news service. “I don’t know how will I repay my loans.”

Some professional investors rang warning bells in recent months, saying emerging-market stock prices could not sustain their torrid pace. Early this year, stock indexes in markets as disparate as Saudi Arabia, Iceland and Vietnam began to look a lot like U.S. dot-com indexes in early 2000 -- heading nearly straight up as buyers poured in.

“This market desperately needed a bucket of cold water poured on it,” Headley said.

Russ Kinnel, director of mutual fund analysis at investment advisory firm Morningstar Inc. in Chicago, cautioned against rushing into emerging markets a few months ago. But it was understandable, he said, that many Americans felt they were missing the party as the stocks jumped amid optimism about the long-term growth of China and other up-and-coming economies.

“People who got in late to emerging markets may have read one too many ‘China’s going to rule the world’ stories,” he said.

Investors also may have been betting that prices for oil and other commodities would remain elevated, buttressing countries that export raw materials. But worries about the global economy have pulled prices of many commodities lower over the last two weeks.

Still, investors who can hold on to emerging-market stocks for the next 10 to 20 years shouldn’t be frightened away by the latest turmoil, Kinnel and other analysts said.

Unlike in the late 1990s, governments of countries such as Russia and South Korea are flush with cash, which should support their economies, Headley said.

“We remain pretty bullish on the long-term story” of emerging markets, said Larry Adam, an investment strategist at brokerage Deutsche Bank Alex. Brown in Baltimore.

He noted that by traditional stock valuation yardsticks, such as the ratio of share prices to earnings, most emerging markets do not resemble the dot-com market of the late 1990s. In that overheated environment, many stocks of fledgling technology companies sold at prices hundreds of times underlying earnings -- if there were earnings at all.

“The price-to-earnings ratios are by no means as outsized as they were in the tech world,” Adam said.

Even with the losses they have suffered in recent days, many emerging stock markets still are in the black for the year. The Russian market, for example, is down 25% from its record high on May 6 but was up 17% year to date as of Monday. The Indian market, which rebounded Monday to a loss of 4% on the trading session, is up 11.5% since Dec. 31.

Among foreign stock funds popular with U.S. investors, the $81-billion-asset Euro-Pacific Growth fund managed by the Los Angeles-based American Funds group has fallen 9.3% since May 9 but still is up 6.3% for the year.

Many of the largest foreign funds used by American investors have the bulk of their assets in European and Japanese stocks, which haven’t fallen as hard as emerging markets.

But analysts warned that further declines could lie ahead in all foreign markets if more investors try to lock in some of their paper gains from recent years.

As for the U.S. recession worries that triggered the market rout, many economists say those fears are overblown. Allen Sinai, who heads consulting firm Decision Economics Inc. in New York, noted that stock markets frequently fell on recession fears that proved groundless.

“Markets are much more volatile than economies,” he said.