Latest Emerging Market Viewpoints
From the North of South Capital team
Argentina: Never as good as it looks… but never as bad
Our mantra on Argentina is that it is never as good as it looks but also never as bad as it looks. We have reduced exposure to Argentina over the past few months as the markets increasingly priced in a certain Macri victory.
Following a preliminary vote, the market has priced in as almost certain that Cristina Kirchner returns to power via a vice-presidential spot behind Fernandez. This is highly likely but there are still months until the actual election and some voters might make the link between this outcome and the immediate economic impact.
Overnight, the Argentine equity market dropped 48% in USD terms and fixed income moved to price in a 75% probability of sovereign default in the next five years. This outcome is not certain but certainly quite possible given Argentina’s history and the build-up of foreign debt under Macri’s leadership (from 26% in 2015 to 52% of GDP by end 2018 – this year’s currency moves will exacerbate this further). The move in the peso was a drop of 17%. It brings the devaluation this year to almost 40%.
The challenge for Argentina as always, is the automatic link to inflation via indexing – local prices will quickly move up to adjust for increased dollar costs, thereby cementing the decline, accelerating inflation and risking further declines. All this happens without improving competitiveness of Argentina’s industry. While a Fernandez/Kirchner election victory is not yet certain, it looks very likely. The great unknown is the degree to which their win will bring back unworkable policies such as price manipulation, currency controls and lying about statistics. For many Argentinian companies this will be a matter of life or death. We believe international investors will not wait around to see what happens.
Currently we have one Argentinian stock in the portfolio, which is an oil company listed in Mexico and via ADRs. It is run by the former head of YPF – an appointee of Christina Kirschner at the time. The company is developing the world-class Vaca Muerta shale deposits that have also been a priority for YPF. Its product is priced in dollars and it is therefore not as affected by domestic cost of capital. The oil it sells internationally will be a crucial source of dollars for the country and we believe the company is among the least likely to be targeted by government price controls. Challenges may arise in funding the growth and access to equipment, although much of this has already been prudently secured. The stock is very inexpensive on all our metrics and we are comfortable with the position.
Some of the Mexican and Brazilian companies we own also have operations in Argentina that account for less than 20% of total in all cases. They are likely to be affected by domestic turmoil although they all have a long history of dealing with the country.
With our mantra in mind, that things are never quite as bad as they seem in Argentina we are interested in such significant declines in asset values and will be monitoring the situation very closely for opportunities when the market has become overly pessimistic. Given the extreme volatility in Argentina’s cost of capital this will of course be a challenge for any businesses that are domestic earners.
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