Sentiment on Argentina is running hot. Really hot. To give one Seeking Alpha-specific example, in 2017, this site published 6 in-depth articles about the primary Argentina ETF (ARGT) all year. This year, less than a quarter in, we’re already up to 7 as of this writing. Why has Argentina gotten 300% more popular this year?
As is often the case, speculators are attracted to whatever is on the move lately. Argentina made people a lot of money last year and thus, attracts the momentum crowd:
While momentum is perfectly fine as a trading strategy, it’s a risky way to pick your investments. With a boom and bust emerging market, you’re generally better off buying before a 50% run-up, not after.
And unfortunately for the bulls, sentiment isn’t the only thing running hot in Argentina. The country is experiencing its worst drought in 30 years – an event that is already causing GDP estimates for this year to get dinged. More on that in a second. But first, let’s tour a couple of bullish articles for the positive view:
Renaissance Research – Argentina: Plenty Of Catalysts Ahead
Renaissance offers a few bullish points. The first of these is that foreign capital is coming back to Argentina. This is certainly true. They further suggest that capitalist president Macri’s reforms are “bearing fruit” – which may be true, though a large portion of the credit goes to neighbor and key trading partner Brazil for pulling out of its slump.
Furthermore, Renaissance suggests that Argentina has a “unique” banking sector since it has a high portion of deposits compared to other LatAm markets, along with lower than usual credit penetration. Renaissance and I have debated these points at length previously. I’ll just leave an astute comment from fellow Seeking Alpha Contributor Federico Cuneo reacting to Renaissance’s claim that Argentina’s deposits are a “stable and cheap funding source”. Cuneo responded:
Argentinians are unique in the world and these deposits are unstable as the VIX index. I don’t have the statistics, but I don’t need them, because I am sure that in the retail market, over 95% of deposits (CDs + savings + check accounts) are due in less than 30 days. That number is not lower because the minimum for a CD deposit is 30 days, if people were given 15 day CD deposits they would pile on those. A long term saver is considered one making a CD for 90 days.
While Argentina does have a high portion of deposits in its banking system at the moment, this is unusually hot money and shouldn’t be seen as trustworthy long-term dependable capital. In my view, a country like Colombia, with nearly as high a portion of deposits/loans but much sticker deposits is far safer for foreign investors than a country like Argentina where savers frequently pull their funds out en masse.
Finally, Renaissance suggests that Argentina has a good chance of being upgraded from a frontier to an emerging market this year. That is correct, I concede that point to the bulls. Then again, when your market is up 50% over the past year (more in peso terms), you could argue that this is already priced in. Remember when everyone front-ran REITs getting their own index classification in the US and then prices went down significantly after the rebalancing finished?
David Zanoni – Investing In The Pope’s Home Country
Zanoni relates the positive economic developments of late in the Pope’s home country – Argentina. Its GDP has picked up, inflation has moderated slightly, and the country remains blessed with an abundance of natural resources. All this is true – no arguments from my corner.
After explaining the Argentine turnaround story, he gets to why the country is still attractive despite the big run-up in equity prices lately, saying that in this case, the Argentina ETF shouldn’t be valued purely on its (high) PE ratio for the following reason:
Instead of merely looking at PE ratios for this fund, I’m doing something a little different with ARGT. I am valuing ARGT as a momentum play. Argentina’s economy performed well over the past year, which caused ARGT’s price to appreciate significantly. Since Argentina’s economy is expected to continue growing, ARGT is likely to continue appreciating. The PE ratios of the holdings in the fund are likely to expand as the economy grows.
As I said at the outset, it’s fine to trade stuff on momentum. But don’t confuse trades for long-term investments. And in the case of Argentina, the momentum could be coming to a close.
GDP Gains To Dry Up?
Argentina is in the midst of a dramatic dry spell this summer. Not only is rainfall below previous years – it’s around 40% below previous drought years, at least for February.
A Reuters article compares this to Argentina’s last significant drought – which dragged Argentina into a recession. Analysts are forecasting this drought to be worse than that one. Remember that corn and soybeans alone make up more than a third of the country’s exports – for a country with sizable budget deficits and runaway inflation, a shortfall of dollar exports is a crushing blow indeed.
For all the (probably overblown) hype you see around Argentina’s energy industry and gold mining prospects, it’s important to remember that Argentina never managed to develop much beyond basic grain industry along with its competition-sheltered autos business for exports (even cattle make up a shockingly small percent of exports): (data 2012, source Wikipedia)
Given this concentrated grain-based export picture, Argentina’s economy risks decelerating if things don’t improve quickly on the weather front. In 2009, another low rain year, at this point in the growing season the government estimated 46 million metric tons of soy production. Final results came in at just 40 million. With significantly less rain this growing season, look for a number even lower than 40 million tons, yet government forecasts are still up at 47 million.
Even with the 47 million figure, analysts already trimmed their consensus Argentine 2018 GDP growth figure from 2.9% last month to 2.5% now. Thus, Argentina is heading for a slowdown in 2018, as 2017 GDP came in at +2.9%. 2018 is heading for just 2.5% and likely more revisions downward as the impact of the drought continues to expand.
Other Macro Factors Remain Problematic
Historically, awful weather is a short-term problem. But it’s far from the only problem longer-term Argentine investors face. For one, that concentration in grain is a serious problem because grains have been among the worst commodity performers over the past 40 years. Hat tip to The Macro Tourist for an insightful article on the subject for further reading. He shows the following inflation-adjusted charts of corn:
While grain prices will undoubtedly continue to experience big short-term swings, technological advances in agricultural production per unit of land has made these products long-term losers. As long as Argentina is tied to the fate of grain prices, expect the economy to be a mediocre (or worse) performer.
On top of that, inflation is hardly stamped out. Inflation had been running in the low 20%s from about 2010 onward, before spiking to the 40s just before the Kirchner government gave way to the current capitalist experiment. Argentina is back to around 20% now – in line with the recent average, but hardly a return to a normal functioning economy. Analysts still see double-digit inflation rates continuing through at least 2019.
Argentina periodically allows pro-business government to run the country for a few years, but don’t give them enough latitude to pull the country into a cycle of sustainable development a la Chile or Colombia.
For one topical example, consider the country’s schools. Schools were supposed to go back into session this week, but the majority of the nation’s teachers are on strike, demanding 24% raise to match inflation (many people distrust Macri’s government’s purported inflation figures as well).
People in the developed world may think you simply have to elect a pro-business government and then, like a light switch, the economy ignites. But it doesn’t work like that. Those of us who have lived in Argentina see deep structural problems that one presidential term can’t come close to fixing. The turnaround will be a long process – and one that will never have time to get off the ground if the country’s finances collapse again. Keep in mind that rising interest rates and spreads will make Argentina’s recent efforts to borrow more money significantly harder.
Lost in the fury to bid up Argentine stock market is the fact that locals are bailing out of the Argentine peso. Here’s the dollar versus the peso over the past year (Bloomberg):
As you can see, the peso has lost another 25% of its value over the past year, with losses accelerating markedly as the growing season turned out to be a bust. Those “stable” deposits in the Argentine banking system may start fleeing to avoid another massive devaluation like what happened in 2001-02. Keep in mind the peso is down 25% in a year when the dollar itself got hammered, you’re looking at close to 40% losses against currencies such as the euro over the past year.
None of this is to say that Argentina can’t keep going up in the short-run. Momentum trades often work well beyond what fundamentals would support. An upgrade for Argentina to emerging market status could kick off another rally.
But the: “Macri capitalist in office so all is good again,” meme is running out of steam. GDP growth is heading downward in 2018 compared to last year (with more downward revisions likely to come). The government hasn’t stabilized its deficits or inflation – and the public sector continues to strike to demand sizable wage hikes. The peso is in free fall. All in all, Argentina is a risky market, and it takes serious nerve to think it’s a buy up 50% from last year at this point.
The Argentina ETF – ARGT – is actually safer, in a way, since it is hyper-concentrated in two companies. MercadoLibre (MELI) is an international e-commerce site and is more tied to the Nasdaq’s fortunes than Argentina’s. And Tenaris (TS), the #2 Argentine holding, doesn’t even have its headquarters in Argentina. And there are some good smaller companies in Argentina – this author owns Despegar.com (DESP) for example.
Regardless, my overall call is to avoid the Argentine economy, and in particular its banks, which are earning unsustainably high NIMs and are also at risk of serious loan losses during the next recession/political swing.
Disclosure: I am/we are long DESP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.