The recent downturn in the U.S. economy is weighing down economies across the globe, but the country feeling the fallout the strongest is just across our southern border. Mexico’s economy is heavily dependent on the U.S.: Around four-fifths of Mexico’s exports are destined for America; Mexicans working in the U.S. send enough money home to account for about 2.5% of their country’s GDP; almost half of foreign direct investment in Mexico came from the U.S. last year; and the country imported $134 billion in goods from the U.S. in 2007.

But despite the interconnectedness of the neighboring economies, Mexican stocks have fared surprisingly well so far in 2008. iShares MSCI Mexico ETF (EWW), which invests in several dozen stocks from Mexico’s sole stock exchange, was down only a fraction of a percentage point year to date on July 18, even as the S&P 500 lost nearly 15% for the same period. Moreover, while many Mexican stocks have dropped sharply, the country has so far avoided the kind of dramatic, broad market declines that many emerging economies have experienced. The relative stability in Mexican markets helped EWW jump to position four on the ETF Momentum Tracker rankings table last week, after spending the previous six weeks ranked sixth.

There are several reasons Mexican stocks may currently appear shielded from U.S. woes. Mexico was one of the first foreign countries to register an impact from the bursting U.S. housing bubble and subsequent credit crisis—so while many foreign markets soared in 2007, Mexican stocks produced only modest gains. EWW gained just over 11% for the year, 33% less than the average fund in Morningstar’s Latin America Stock category. So Mexican stocks today may have less far to fall than their high-flying brethren.

Mexico also is cushioned from the impact of the U.S. downturn by its extensive access to commodities—especially oil. Mexico is the third-largest supplier of oil to the U.S. and is the world’s eighth-largest crude exporter. Astronomical oil prices have generated huge revenues for the government, which controls the country’s oil industry. Much of those revenues are being invested in infrastructure projects that should boost economic growth. Mexico also exports silver, copper, fruits, coffee, cotton and other major commodities—so as long as commodities prices soar, Mexico should be able to fend off the worst effects of the troubled U.S. economy.

While the U.S. still remains by far Mexico’s most important trade partner, Mexico has also steadily increased the amount of exports it sends to other nations in recent years. Mexico’s trade with Costa Rica, Chile, Honduras and the European Union has grown rapidly, helped along by a number of trade agreements. Diversifying trade may be one more reason why Mexican stocks haven’t fallen as far in 2008 as might be expected. EWW’s portfolio is dominated by stocks in telecommunications firms such as cell phone provider America Movil (AMX), basic materials firms such as cement manufacturer Cemex (CX), consumer-oriented firms such as Wal-Mart de Mexico (WMMVF.PK), and financial services firms such as Grupo Financiero Banorte. About half of the fund’s assets are usually invested in its top three holdings, and recent top holding America Movil alone has long held more than a fifth of the fund’s assets.

America Movil lost nearly 14% year to date through July 21, but the fund’s rapid growth and massive scale leave most analysts optimistic about its long-term prospects. Some investors were disappointed with the firm’s first-quarter results, but the second-quarter report this week is expected to show a recovery in revenues and profits. America Movil, the largest cell-phone company in Latin America, claims 70% of Mexico’s market share, but it has also expanded into Central and South America, accumulating more than 140 million customers along the way. The firm could face intense competition in the coming years, and it sorely needs to increase its profit margins outside of Mexico. Even so, America Movil is positioned to dominate the Latin American telecommunications sector for years to come.

Recent EWW number two holding Cemex also lost about 14% year to date through July 18. The stock’s poor performance can be traced back to the deflating housing bubbles in the U.S., Spain, the United Kingdom and other countries where Cemex does business. Still, since purchasing competitor Rinker in 2007, Cemex has become one of the largest cement makers in the world, giving it a lock on huge market shares in a broad array of countries. Cemex may face hard times if the economies of those countries worsen, but once the current building bust is over, Cemex is likely to pick up on its previous pace of steady growth.

If Mexican markets remain somewhat aloof from the U.S. downturn, EWW’s momentum may outpace other foreign-stock ETFs. But it appears unlikely that this fund will generate outsized returns anytime soon. The Mexican economy is expected to grow only 1.9% in 2008, slowing from 3.3% growth in 2007. Moreover, unemployment appears to be growing, industrial production is slowing and inflation is a major concern. For investors seeking exposure to stocks outside the struggling U.S. economy, that may sound all too familiar.

• iShares MSCI Mexico: Surprising Strength South of the Border  »
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• Is Sonora State Mexico's Carlin?  »

Don Dion

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