Post-Primaries: Q3 Argentina Update

Introduction

Prior to the surprising result in the presidential primaries, Argentine markets were having a record year – up 42% YTD on August 9th.1 Since the primaries, yields on Argentina’s sovereign 100-year century bonds have risen 38%, but in June the real exchange rate rose faster that it had in four years and inflation decelerated for the third consecutive month.2 The international community seemed assured by the IMF approving greater Central Bank intervention and granting a $5 bn disbursement in April.

In the wake of an extreme market selloff following the primaries, it’s easy for investors to forget these constructive economic signals and to become singularly focused on the political situation in Argentina. Yet the continuation of positive economic momentum through and beyond the election, regardless of the winner, should remain the top priority of politicians and the focus of investors.

Peaking at the Primaries

Despite laudatory remarks from the IMF and Argentina’s strong market performance earlier in the year, Argentina’s economy was and still is in recession, but improving. Inflation is decelerating, but still up over 50% year-over-year (YoY).3 Yet, the economy directionally is showing signs of improvement. Inflation has shifted from Consumer Staples and Utilities to Consumer Discretionary items, as price freezes and a strong harvest are helping to steady prices. Consumers began spending on Communication Services, Health Care and home maintenance, while consumer confidence has increased 11% since January.4

On the Friday preceding the primaries, markets rallied in anticipation of a tight race that would favor the market darling, incumbent President Marci. When he lost by a margin nearly triple the moderate 5% forecast, it stoked fears that he would be unable to recover the votes necessary to win the first round on October 27th, sparking a market rout that dragged the peso down with it. And while the Global X MSCI Argentina ETF (ARGT) was not insulated from Sunday’s event (falling 24% in dollar-terms on the Monday following the primaries), it outperformed the local MERVAL index by 23.9% owing to its large-cap exposure.5

Disrupting Politics

After winning the 2015 elections on a narrow margin in the runoffs, Macri’s Cambiemos coalition disrupted the political landscape in Argentina by pushing forward on key reforms and pulling legislators across the aisle towards the center. Macri’s hurdle before October will be to sway voters that chose centrist candidates like Roberto Lavagna in the primaries, while preventing challenger Alberto Fernández from doing so. Regardless of the outcome, the election winner will then be faced with the challenge of maintaining the positive economic momentum that caused markets to rally earlier in the year, as well as continuing to prevent further bouts of inflation and unemployment.

And although a populist-led government seems more likely than it did before, a full reversion to Peronist policies does not seem likely despite familiar elements of the ongoing recession and the lingering presence of Cristina Fernández de Kirchner as Fernández’s pick for Vice President. Today’s responsive and market-friendly policy framework, which was largely absent in Argentina’s populist past, has begun to improve structural issues, ultimately contributing to the market run-up earlier this year.

Finding Opportunities

Going forward, the markets will likely ebb and flow in response to the country’s overall economic health and the shifting political landscape, as candidates form their cabinets, political alliances, and policy frameworks. These developments could create opportunities for tactical investors to express their views on the market outlook around elections and economic releases.

Since the primaries, valuations have fallen steeply across ARGT based on price-to-earnings, price-to-book, and price-to-sales metrics. Yet, sectors in Argentina, which have been more sensitive to the downturn – namely Financials, Utilities, and Energy – may be most attractive for those looking to further narrow their exposures leading up to the October 27th elections or a potential runoff on November 24th.

Source: Bloomberg as of Aug 20, 2019. Post Primaries refers to Aug 19, 2019, Day Before Primaries refers to Aug 8, 2019, P/E refers to Price-to-Earnings, P/B refers to Price-to-Book, P/S refers to Price-to-Sales, Div Yield refers to Dividend Yield.

Past performance is no guarantee of future results. For standard performance information for ARGT please click here.

Talking Head- and Tail-winds

Headwinds are obvious as they relate to staving off a vicious cycle of inflation, currency depreciation, and negative market sentiment. These threats combined with maturing debt with elevated credit spreads all weigh on sentiment and will need to be addressed in order to return Argentina to its path earlier this year. However, several tailwinds could also provide a backstop for the markets, which are likely to remain volatile leading up to the fall elections:

  • Maintaining Momentum: Recent signs of economic improvement could be key to stabilizing markets. Data from July showed a strong improvement in inflation and consumer confidence this year. And while inflation is rising for certain consumer discretionary goods, it overall has been decelerating for three straight months.
  • Trading the Harvest: Improved trading relations, combined with Argentina’s record harvest may improve Macri’s election outlook. in close coordination with regional powerhouse Brazil, and under a stronger Mercosur umbrella, Argentina has pushed forward on negotiations for a long-awaited trade deal with the US and EU. And as US-China trade negotiations stall because of sticking points related to agriculture, Argentine officials in August welcomed their Chinese counterparts – making strides on years-long negotiations to improve trading relations and boost key agricultural exports, including soybean and higher-value soymeal.
  • Leading from Behind (Central Bank Walls): The Central Bank and IMF have served as ballasts for international investors. Despite market volatility, two ratings downgrades by S&P and Fitch, and the recent departure of the Economy Minister Nicolas Duvojne, the Central Bank and IMF appear committed to nimble and responsive policies rather than succumbing to reactive firefighting tactics. Foreign exchange reserves are at an all-time high, giving the Central Bank necessary buffers – and according to Central Bank head Guido Sandleris, all it needs to curb depreciation – alongside continued support from the IMF.
  • Coordinating Policy with New Leadership: After taking office, the new Economy Minister Lacunza announced that IMF will be visiting Argentina this week as part of the approval process for the latest loan disbursement. While the Central Bank and the IMF have helped Argentina maintain its record high levels of foreign reserves, the Economy Ministry under Lacunza has been actively reducing its foreign-denominated debt exposure to reduce the peso’s vulnerability to foreign exchange movements. After joint announcements from the Economy Ministry and the Central Bank, the peso recovered nearly 9% after spiraling to a low three days after the primaries.6

Conclusion

Centrism, consistency, and pragmatism in both politics and monetary policy will be critical to the success of Argentina’s next President, as well as investors. Continuity of initiatives spearheaded by Macri, including the expansion of infrastructure projects like public-private-partnerships (PPPs) across the energy sector, negotiating a EU-Mercosur trade deal, and coordinating with Brazil on a US trade deal, would be well received. In the short-term, investors will be attentive to yields on Argentina’s sovereigns and corporates, economic data releases, currency movements, and polling data, while they may form a longer-term outlook based on consolidation across Presidential campaigns and elucidation on policy framework.

Related ETFs:

ARGT: The Global X MSCI Argentina ETF invests in among the largest and most liquid securities with exposure to Argentina.