Back in the 1990s. there was a British TV commercial for a drink called Orange Tango. An unsuspecting guy tasted the drink. Then an orange painted man ran up and slapped him hard in the face with both hands. In Argentina, the home of the tango dance (and also my chosen home), investors have developed an inexplicable taste for stocks and bonds. Sooner or later they’ll get slapped in the face as well.
“You know when you’ve been tangoed.” That was the claim of the commercial. Apparently, the prospect of a physical shock made the drink more enticing. (You’ll find the commercial here. It’s no surprise that it led to a mini-epidemic of face slapping in schools…)
I happen to live in Buenos Aires city, where I moved in 2008. Until late 2015 the country was run by a populist and especially incompetent government. Under Peronist president Cristina Fernandez de Kirchner (“CFK”) the government went about its business of grinding the economy into the floor.
At one point I thought Argentina was headed in the direction of Venezuela, and thoughts turned towards leaving. The latter is now in hyperinflationary meltdown and teetering on the edge of a civil war.
Fortunately a minor miracle happened in late 2015. Despite all the propaganda, government expenditure budgets (both official and, ahem, unofficial), and somewhat chaotic opposition, just enough Argentines voted to kick CFK out of office. The Peronists were replaced by a coalition called “Cambiemos” (“Let’s Change”), led by new president Mauricio Macri.
Macri quickly set about fixing the biggest problems. The false, official exchange rate was quickly allowed to “devalue” to the genuine, market rate. Huge export taxes on most crops and meat were removed.
Indiscriminate subsidies on utility bills were slashed. In the space of 18 months, my own monthly electricity bill went from a pitiful US$3.50 to around US$35 (which is still cheap).
Capital controls were relaxed. A tax amnesty resulted in the declaration of assets worth about 20% of GDP. Which, to put it in perspective, is equivalent to about US$4 trillion of private money suddenly appearing out of nowhere…if it happened in the USA.
These are just a few of the biggest changes so far. The full list is much longer. And the list of what’s left undone is longer still. Most notably there’s a huge need for deep tax reform, including huge import duties.
Progress is being made. But Macri has a minority in the Congress and we won’t know until October if he can turn that into a majority. Either way, the reality is that the country was left so wounded that it needs a long time to heal. Here’s a short update that I sent last week to subscribers to the OfWealth Briefing.
“This morning’s TV news said Argentine unemployment is about 11%. Inflation is still well north of 20% a year, although down from the 40s of the past couple of years. Prices in the shops are currently high in US dollar terms, and the currency looks like it needs to be devalued. There’s still a big government budget deficit of 4% of GDP. And economic growth remains elusive.
As the government battles to normalise the economic and financial system (I can now do direct dollar bank transfers from abroad for the first time since I arrived in 2008!) there are ongoing social tensions.
Bus drivers have been on strike this week in both the capital and Cordoba, the country’s second largest city. Teachers were on strike (again) yesterday. Motorcyclists blocked a major avenue in central Buenos Aires last night, in protest against new measures designed to improve safety and reduce crime. (Motorbikes are the preferred method of transport for many delinquents. There’s even a local word for such criminals, the “motochorros”.)”
One of the ongoing problems is that the Argentine peso seems far too strong. That damages competitiveness in export markets. (Not to mention that Argentina’s main export market is Brazil, which isn’t exactly peachy at the moment. In fact, it could be said that it’s distinctly “impeachy”.)
To illustrate the peso problem, I had lunch at an Asian restaurant the other day. A modestly sized bowl of beef and noodles, two small bottles of beer and a still water came to almost US$40. Trust me, that’s insanely expensive in a country where half of employees earn less than US$600 per month, and 90% earn less than US$1,200.
Argentina certainly still has problems. But I’m cautiously optimistic that its worst days – the 1970s dictatorship, 1980s hyperinflation, early 2000s default and depression – are unlikely to be repeated. It became a democracy in 1983, and hopefully it will start to settle down.
So, in a sense, investors can be forgiven for their newfound interest in Argentina. But let’s pause and remember the words of Nobel prize winning economist Simon Kuznets (1901-1985): “There are four kinds of countries in the world: developed, underdeveloped, Japan and Argentina.”
In other words Argentina makes no sense. I remember reading something like this in a research report years ago: “The Argentine government is always trying to reinvent the rules of economics.”
In the early 20th century the country was one of the richest in the world. Then the political rot set in…and spread. Practically anywhere you find widespread poverty and failure you can trace the causes back to bad politics.
Since the 1930s most Argentine governments have either been “Peronist” (opportunistic populists named after Juan Manuel Peron) or military dictatorships. Therefore, financial crises have been unsurprisingly frequent. Those include hyperinflation in the 1980s and a massive debt default in December 2001, followed by a huge currency devaluation.
Argentina’s been caught in a vicious circle of political and economic failure. (Sidenote: modern day Europe beware.) Jorge Piedrahita, chief executive of Puma Investments, was recently quoted as saying: “When you look back in history, I’m not sure we can find a 20 year period where Argentina has not defaulted.”
And yet, what’s this? The Argentine government has just issued a US dollar bond that matures in…wait for it…100 years! With 7.9% yield in a low yield world, eager (desperate?) investors lapped it up. The US$2.75 billion bond was 3.5 times oversubscribed.
Of course, it’s reasonable to think that Argentine bond spreads could narrow against US treasuries if the country keeps improving for a while. So current investors could see nice capital gains in the next few years, even if treasury yields rise. Or at least no capital losses and a juicy yield.
But, ultimately, someone has to own these bonds. They’re now in the market. It seems highly likely that they’ll default at some point, blowing a nice little hole in certain portfolios. This looks like a time bomb.
And if the bonds don’t default? The Argentine government is paying higher interest than if it had borrowed for a more normal period of say 10 or 20 years.
Apart from bond investors, stock investors seem over enthusiastic about Argentina as well. Argentine stocks have enjoyed a massive bull market.
The MSCI Argentina Index is up an incredible 3.5 times over the past five years, measured in US dollars. The local BURCAP index is up seven times over five years, measured in Argentine pesos. (The BURCAP is weighted by market capitalisation of the companies, which makes it more relevant than the better know MERVAL index, which is weighted according to trading volume.)
This has left stocks pricey, to say the least. At the end of May the MSCI Argentina Index had a price-to-earnings ratio (P/E) of 30. It’s dominated by banks, utilities and the state-controlled oil company. Hardly the stuff that dreams are made of.
Given the economic mess during that period, and what still remains of it today, it’s extremely hard to rationalise any of this. Viewed from the ground it makes no sense at all. Investors became optimistic during the bad years between 2011 and 2015. Then they went into overdrive since then, once the government changed from useless to average.
One big problem is the peso. It’s overdue for a fall, at least if the current dollar cost of living is anything to go by. My gut feeling is it needs to lose about a quarter at today’s prices. And inflation is still running around 20%, although perhaps will fall to mid- or even low teens next year.
So let’s say – hypothetically – the peso needs to lose 40% against the US dollar over the next couple of years. That would take it from 16.16 pesos per dollar to around 27. That’s to restore a bit of competitiveness in export markets. Why would anyone pay huge multiples today to buy stocks of companies with future streams of peso earnings?
Put another way, when inflation rates were in the teens in the US in the 1970s, stocks traded down to P/Es below 10. In Argentina, with inflation shooting up above 40% in recent years and only now heading below 20%, the market is trading three times as expensive. It makes little sense to me.
Tonight (Tuesday 20th June) the index provider MSCI will announce whether it will re-include Argentina in the MSCI Emerging Markets index. It was previously downgraded to a frontier market in 2009 due to capital controls.
Personally I think it’s still too early, and the country isn’t sufficiently fixed. But the decision will have been announced by the time you read this. If Argentina is upgraded then a lot of emerging market tracking funds will pump even more money into the Argentine stock bubble.
It’s a small stock market, about 6% as big as Brazil’s or 12% of Mexico’s and a rounding error globally. Prices could go higher. But ultimately this can’t end well. As all those populist Peronists have eventually found out in the past: market fundamentals always win in the end.
One final word of caution. Former President Cristina Fernandez de Kirchner may be down, but she isn’t out. While I was writing she was speaking at a rally of tens of thousands of supporters in a football stadium. I turned on the live broadcast on my TV.
Whatever her many faults, CFK is an excellent populist orator. She can conjure up tears on demand in a manner that any budding actress would kill for. The credulous crowd is lapping it all up. Apparently there’s no limit to some people’s gullibility.
The actress wants to play the role of senator. This is not least because it ensures immunity from a long list of corruption charges that are grinding through the courts.
Whether or not she’s successful…or even runs for president again in future…the huge rally reminds me that populism still has a ready audience on this side of the Rio de la Plata.
One day there will be yet another Peronist government in Argentina. When that happens there will only be one thing to say to investors in Argentine stocks and bonds. “You know when you’ve been tangoed.” Again.
That said, there will be a good time to buy Argentine stocks. Most likely they’ll be dirt cheap after the next global crash. But given their high prices after a five year bull run, and the overvalued peso, it’s hard to get excited right now.
Stay tuned OfWealthers,
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