I am an interested observer of the stock market of the southern cone of South America. The major economies of the continent are Argentina, Brazil and Chile and have active stock markets with many issues trading as ADR's in the U.S. During good times these markets have provided investors with outstanding returns. For example, the iShares S&P Latin American 40 Index Fund (NYSE:ILF) had average annual returns of 49% for the 5 years from 2003 to 2007. Rough compounding from the start of 2003 until the end of 2007 gives a total return of 630%!

These stock markets generated their growth on three legs: First, internal growth of their economies and manufacturing bases. Second, rising commodity prices of which South America has in abundance from soybeans to copper. Third, the falling dollar expanded the gains when local currency was converted to dollars in ADR's.

In the last year this 3-legged stool has become a one-leg (maybe) and the stocks and ADR's from the region have fallen even further than the U.S. markets. Let us take a quick look how each of the southern cone markets has performed over the last year.

The Merval Buenos Aires (MERV) closed yesterday at 951.79, off 58% from its high in December 2007. The recent low was 819 on 11/21. Political maneuvering in the pension and tax systems make Argentina a scary place for stock investors. The only company of interest trading there is the online auction company Mercadolibre (NASD:MELI). Otherwise, steer clear of Argentina.

Chile's major market index, the Santiago IPSA (IPSA) closed at 2317.95, just 30% down from last December's peak. The recent low was set on October 10 and the Chilean market has recovered 15% since then. U.S. investors can easily invest in Chile through the iShares MSCI Chile Investable Mkt Idx (NYSE:ECH). Chile's biggest problem has been a strong devaluation of its currency. ECH is over 50% off its highs while the Chile market is only down 30%.

Brazil is by far the largest economy in South America and offers lots of options for stock investors. The Sao Paulo Bovespa (BVSP) closed yesterday a fraction above 35,000. This is off 52% from the high set in May. The recent low for the index was 29,435 on October 27. Dollar strength plus Real weakness hit U.S. investors even harder as the iShares MSCI Brazil Index (NYSE:EWZ) is 67% off the recent high.

The South American stock markets seem to have established valuation bottoms in late October and have gained ground since then. For U.S. investors a stable or weakening dollar and strong local currencies are the key to converting stock gains to ADR or ETF profits. A recovery in commodity prices will also benefit these economies tremendously. Of the three markets, Brazil's economy will have the strongest internal growth with many basic service companies that look like growth stocks. EWZ seems to be the best opportunity to take advantage of any turnaround in the Brazilian stock market. In Chile, I would look at individual stocks with significant international business like LAN Airlines (NYSE:LFL) or Vina Concha y Toro S.A. (NYSE:VCO). There is still a significant risk of further decline in these markets but when the recovery starts they should significantly outperform the U.S. markets.