For professional investors only.  

For every investor, there can be a market event, trade or position that demonstrates why they follow their specific investment philosophy and process. We think that recent events in Argentina demonstrate why we do what we do.

For background, Argentina, originally an emerging market (by MSCI’s definition), was downgraded to frontier market status in 2009 in the aftermath of the 2001 economic crisis and the destructive populist policies pursued by the Peronist governments of Nestor Kirchner and Cristina Fernández de Kirchner (hereafter, CFK). When the electorate had finally had enough of debt defaults, inflation, capital controls and scattergun interventions in businesses, the 2015 election returned a government under current-president Mauricio Macri which promised to pursue more orthodox economic policies.

This political shift found great favour with international investors, who drove a sharp re-rating of the Argentina equity market, a large fall in the country’s bond yields, and an upward move in the real effective exchange rate. Once this was firmly established, MSCI responded by upgrading Argentina, with the market re-entering the MSCI Emerging Market index in May 2019. All seemed set for a virtuous cycle of reforms, investment, growth and capital inflows, except… the Macri administration was unable to really deliver on its promises. President Macri retained a popular mandate at the 2017 elections, but as the economic crisis worsened, with soaring inflation and a seeming inability for Argentine policymakers to commit to a single monetary policy framework, the 2019 presidential election began to loom as a serious risk point. With popular disenchantment with orthodox economic policies, there was a growing risk that the 2019 election would return the Peronists (this time with CFK running as vice-presidential candidate alongside presidential candidate Alberto Fernández).

On 11th August, primary elections were held by each party to choose their candidates for October, but the unusual structure of Argentine elections (with primaries held simultaneously) means that turnout in the primaries acts as a powerful poll for the full election. Fernández won 47.4% of the total vote, against Macri’s 32.3%.

This result has meant that Argentine financial markets had a good go at unwinding several years of recovery-driven gains in a few days. The yield on, for example, on Argentina’s April 2021 USD bond, rose from 15.3% on Friday 9th August to reach 49.5% on Wednesday 14th August. Bloomberg reported that the 48% fall in the Merval stock index on Monday 12th August was the second-largest one-day fall in any global equity market in the last 70 years (Sri Lanka’s 61.7% fall in June 1989, as the country slid into civil war is the worst; showing that one should always study the form guide, Argentina also holds third place with the 45.2% fall when the banks re-opened in January 2002). At a stock level, the ADRs of Banco Galicia, BBVA Argentina and Banco Macro fell 56.1%, 55.9% and 52.7%, respectively, on the Monday.

Falls of this magnitude reflect markets rapidly pricing in new information, yet that news does not exist at the stock level and will not be anticipated by a stock selection process. It remains our view that the two most important drivers of a classic company DCF model – the risk free rate and the currency used to bring a local currency valuation back to an investor’s base currency – sit at the country level and can only be adequately monitored through a macro-driven, country-focused process. Yet, the dominant approach to EM equity investing continues to target the best companies/stocks, and largely or totally ignore macro-level risk and opportunity. We suppose there must be some sense of pride for a stock-picker in managing to pick the Argentine bank that performed the best on Monday, but we would rather just be zero-weight Argentina, as our country-focused process leads us to.

Argentina’s policy-making structure is weak, we believe that the peso has been overvalued (Q1 2019’s current account deficit still represents an annualised rate of 3% of GDP), and the political system that has supported the market’s recovery is in serious risk of capsizing. This feedback loop of politics and economics can be very dangerous for investors when headed downwards. From a market point of view, the equity market, which has recently been trading at around 11-12x forward price/earnings ratio, has substantial downside risk given that the valuation multiple fell to below 4x in 2012-13 (data for MSCI Argentina, from Bloomberg). We have been cautious on Argentinian stocks, purely because of our macro-framework, and do not see any data points that yet cause us to want to change our collective mind. We still think that emerging markets go right or wrong at the country level.