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08/05/1998 16:00:26 EMERGING MARKETS-Dow seen dominating trends

By Diane Craft

LONDON, Aug 5 (Reuters) - Emerging financial markets once

again have chosen to trade in line with the lowest common

denominator -- this time the plunging U.S. stock market -- and

analysts say that trend is likely to dominate in the short run.

Over the past two days, both emerging equity and debt

markets have tumbled as the Dow Jones Industrial Average shed

nearly 400 points, or roughly four percent of its value.

"It's looks as if whichever way you turn emerging markets

face one problem or another -- if it's not the yen, it's the

U.S. equity market," said Geoffrey Dennis, global emerging

market equity strategist at Deutsche Morgan Grenfell in London.

By the close of trading on Tuesday the International

Financial Corporation's Composite index, which tracks 1,414

stocks across emerging markets, was off 2.64 percent from

Friday's levels at 205.26.

The Brazilian Bovespa index registered Latin America's

sharpest losses, falling by 7.92 percent since Monday to 9,859.

Even emerging market debt, once heavily correlated with the

U.S. Treasury market, has followed the Dow lower.

Yield spreads on the closely watched J.P. Morgan EMBI

emerging debt index have widened to 656 basis points over the

stripped curve of the U.S. Treasury market since late Friday,

when the index closed at 621 over.

That compares with 461 over on April 30, when the Dow ended

some 576 points higher than Tuesday's closing level of 8,487.31.

Analysts said emerging financial markets would continue to

trade in line with any indicator which smacked of risk -- be it

the U.S. equity market or the dollar/yen rate. Risk aversion had

become the catchphrase for investors who were badly burned by

the Asia crisis.

"It's not the case that slower growth in the U.S. is going

to have a direct impact on these markets, but the key is

investor behaviour," said Sonja Gibbs, chief strategist for

emerging Europe at Nomura Securities.

"If the perception grows that equities are becoming more

risky, naturally it will affect markets perceived as most risky

first."

Dennis said investors would not want to look at emerging

markets if the Dow continued to fall because they would again

run for cover to safe havens such as the U.S. Treasury market.

"At this precise moment, this is not good for emerging

markets. If we get further short-term declines, I think emerging

markets are going to struggle," he said.

Peter West, chief economist of BBV Securities, said a

rebound on Wall Street would steady investor's nerves but

sentiment towards emerging markets would grow even more negative

if U.S. shares continued to slide.

"With the Dow Jones going down, it will add to deflationary

worries in the world economy, and that makes things worse for

commodity producers in emerging market economies in general, and

their financial markets," he said.

But analysts said investors should not panic too much,

because the underlying economic fundamentals in Latin America

and emerging Europe remained favourable.

"It's a sign of nervousness globally that we are following

the Dow more than anything else," said Jerome Booth, head of

emerging market research at ANZ Investment Bank in London,

referring to emerging debt markets.

"Once people calm down a bit, you will see that relationship

cease and the new motivating force in our market at some time in

the next few months will be the desire to have high yield."

Booth said many investors were waiting on the sidelines.

"It's a fantastic time to buy the market because it is

oversold, but having said that, short-term there is still some

market risk," he said.

Other analysts said the herd mentality towards emerging

markets should start to dissipate as long as a financial

earthquake, such as a collapse in the Dow to the 7000 level or a

Chinese currency devalution, did not occur.

Gibbs said domestic factors should come into sharper focus

and a two-tiered structure was likely to emerge, with the

riskiest markets suffering most.

Dennis agreed: "I don't think the markets will rally today

but I do think investors should pick up shares in quality

markets in the next few days on weakness, and I mean markets

like Brazil, Argentina, Poland, Greece, Portugal and Hungary."

But he added: "I don't mean Asia, because I think Asia is

going to underperform." ((London Newsroom, 44 171 542 5110,

fax 542 8688, uk.emergingmarkets.newsreuters.com))

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