Is there an old-fashioned emerging markets buying opportunity in Argentina?
The country settled its outstanding international debts (and lawsuits) in April, and the new reformist government has completed nine months in power while maintaining a popularity rating of more than 50 per cent, so this sounds positive.
Neighbouring Brazil, hugely important to the Argentine economy, has hit bottom and started to rebound, as far as capital markets are concerned. Despite everything, Argentina remains the third-largest economy in Latin America, and it is as blessed with natural resources as ever.
Emerging markets as a whole are also enjoying an upswing. Argentina, after its decade in the wilderness, is not even an emerging market, as far as the indexer MSCI is concerned. If ever there was an opportunity to pile into a value opportunity, this would appear to be it.
That was the message of a renewed charm offensive this week, as President Mauricio Macri and his team met investors at the New York Stock Exchange, at a Financial Times conference covering “The New Argentina”. Judging by the crowd they attracted, there is plenty of interest.
And yet. Argentina, notoriously, has been here before.
“The New Argentina” is even the title of a song from the musical Evita, which tells the story of the rise of the populist Juan Perón 70 years ago. Argentina’s political instability, and penchant for populism, defaults and devaluations, makes investors wary.
And Argentina’s opportunity, and its greatest risk, come to the same thing. After its years in the wilderness, it has a financial system that is far too shallow for an economy of its scale. Bank assets, at 35 per cent of GDP according to SNL, are tiny compared to Chile or Brazil (about 130 per cent), or even Colombia or Peru (66 and 70 per cent respectively).
Volume on Buenos Aires’ stock exchange is minuscule. According to the World Federation of Exchanges, it ran at 156,000 trades per day last month — not even one per cent of the 20.2m shares that trade daily on the Bovespa in neighbouring Brazil, and less than half the volume in Chile, which has a smaller economy and a smaller corporate sector.
Brazil has serious political and economic problems of its own, but it still has a deep and functioning stock market. Argentina, for a country its size, does not. The Merval’s behaviour, doubling in dollar terms since a political transition became likely in the summer of 2013, with many swings along the way, shows that illiquidity.
Local capital markets are tiny, and thanks to the last administration they do not benefit from the substantial pools of capital that have developed in the state-sponsored private pension plans of Chile, Peru, Mexico and Colombia. All of those countries have adopted plans in which workers must contribute to funded pension plans.
By 2014, according to OECD figures, this had created total pension assets under management of $195.5bn in Mexico, and $165.5bn in Chile. Colombia and Peru pools of capital total $63.7bn and $38.3bn respectively. Argentina also adopted such a pension system, but abandoned it in 2008, in favour of a government pay-as-you-go plan. This makes it far harder to develop a local capital market.
Providing Argentina’s economy can be put on even keel, the opportunity is obvious. Markets will inevitably deepen, the financial system will expand, and those who invested early will profit. Reinstatement as an MSCI Emerging Market would attract huge inflows. Steady improvement of its credit rating over time should bring yields down nicely from 6.6 per cent to something closer to Colombia’s 3.35 per cent, or at least Brazil’s 4.63 per cent.
The risk is equally obvious. With such little volume and so little liquidity, there will be no way to get out if things go wrong. The upside is great, but so is the downside.
The risks are almost wholly political. If Argentina’s people can be persuaded to stick with a path that for the time being means double-digit inflation and a recession, then a broadening of markets is close to inevitable. The question of whether they will let this happen is a political risk — just the kind that investors dislike taking.
For the time being, this looks like the ideal situation for long-term institutions to profit from, via private equity. Those with a shorter-term perspective have the possibility of a high return, but it comes with a lot of risk.