FIS Argentine outlook for 2019 plus other emerging markets

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Frontier markets slumped in line with other non-dollar denominated markets in 2018; though outside of Argentina (which fell by -50%), frontier markets as a whole outperformed even the U.S. Never the less In mid-2019 Argentina will “graduate” back into the MSCI Emerging Markets (EM) index.

In 2018 Argentina fell victim to a stereotypical emerging market currency crisis, where high USD debt and rising rates caused a run on the currency that ultimately could only be stopped by ratcheting up interest rates to astronomical levels and turning to the IMF for support. In last year’s outlook, we foresaw this the scenario almost exactly as it ultimately played out:

From our 2018 Frontier Outlook:
Over two years into Macri’s Administration, Argentina’s fiscal deficit continues to be materially worse than their other EM peers and the spending is increasingly financed by dollar-denominated debt, now approaching 40% of GDP, one of the highest such levels in the emerging world.

Unfortunately, we were too dismissive of the probabilities of this scenario, surmising that “for the meantime, the market seems fully on board with extending his [Macri’s] administration a longer benefit of the doubt.” That benefit of the doubt apparently lasted just a few months beyond our publication. Fortunately, we remained circumspect enough of the risks not to venture back into the market in our EM accounts, as we had done very successfully in 2016-17.

Contrary to many of their predecessors facing similar crises, the Macri Administration adopted a classic orthodox monetary policy in ratcheting up interest rates to a peak of 75%. Such monetary austerity has had the predictable outcome of stabilizing the currency at the expense of launching Argentina back into a recession.

The MSCI Argentina now trades below its pre-Macri level, which on its face is too pessimistic as Argentine economic governance remains substantially improved, in spite of the current crisis. But presidential elections in October may not permit the Macri Administration the necessary time to turn the economy around.

Argentina’s fiscal, trade, and current account balances have only barely turned the corner and still have a long way to go before FX pressures are sufficiently in the rear-view mirror so that rates can be lowered sufficiently to permit the economy to grow again. And unlike Turkey, Argentine lending still flows disproportionately through fiscal and quasi-fiscal levers (another legacy of long-time Peronist domination of government), making the adjustment stickier and slower.

Already polls indicate that more than 60% of Argentines have a negative opinion of Macri, though, in a country where most politicians are met with deep cynicism, this puts him broadly in line with his principal political peers. Chief among the potential rivals in October remains the former President of Argentina, Christina Fernandez Kirchner (“CFK”). CFK is widely believed to want to return to power, but is also embroiled in various corruption investigations stemming from her time in power and may not ultimately get the support of her own Peronist party.

For Macri, a CFK -Macri head-to-head is likely his best shot at returning to the Rose House in October. Without a very quick turn around in the economy, Macri must convince the population that the other candidates (especially CFK) are corrupt and/or would make the economy even worse.

This would be easier to do with a known opponent like CFK versus a third-party candidate that doesn’t have the baggage of prior failures. Currently, the favorite such third- party candidate that has the local Argentine media abuzz with excitement is Roberto Lavagna. Mr. Lavagna was the Economic Minister of Argentina from 2002-2005 and is widely credited both inside and outside the country as having guided the country through the last major crisis, or at least not messed up when commodity prices started to rise enabling Argentina to climb out of its own trench of economic failures.

Based on recent polling, he is seen as the most popular politician among the likely contenders in the October election. He polls almost equally favorably among pro-Cambiemos (Macri) and pro-FPV (CFK) voters and mock polls even showing him beating President Macri by almost 2:1 in a second-round runoff.

The good news for investors is that a Lavagna presidency would likely be well-received by markets. He is certainly left of Macri but is widely viewed as a responsible and astute center-left Peronist who having inherited austerity would be more likely to see the economy through the current crisis than completely reverse course as CFK or one of her acolytes might do.

But the road to the election in October is long and at the same point in 2015 Macri was still considered a longshot. Were it not for the elections and the risk of policy change, we would likely be back in Argentina now within our EM tactical accounts, looking to cash in again on the same recovery story we benefited from with our 2016-17 positioning. But given the elevated risks of policy change, and now negative growth until interest rates come down, we will stay on the sidelines. Indeed, should Macri begin to recover in the polls, we would still be likely to leave the first 20% or so of the next rally on the table and jump in only after the political situation was sufficiently clear.

By that time, Argentina will have been re-elevated to the MSCI Emerging Markets Index. Unlike in UAE or Pakistan, much of the Argentine market is very liquid and listed via ADRs on the NYSE, so we could see near-term benefits from the EM upgrade as Argentina should see faster takeup by a wider universe of investors than previous market upgrades…depending on the political economy of Argentina come this Fall.

To read their full Emerging Market report:

Source: FIS Group

About FIS Group

FIS Group is an investment management firm that provides customized manager of managers investment solutions for institutional investors.

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