Last Wednesday (29th August) the Argentine peso lost over 7% against the US dollar. Thursday it lost another 12.5%. It’s been cut in half over the past year. In dollar terms, the MSCI Argentina index is down 57% since it’s January top. But it’s still not a bargain, given the high inflation rate and political uncertainties.
Over the past couple of years, I’ve regularly warned that investors were far too optimistic about Argentina. The country elected a new government back in late 2015, and it’s made a lot of economic reforms that make sense. But many decades of mismanagement don’t get fixed overnight. Investors seemed blind to the realities on the ground.
Back in June 2017 – partly due to investors being enamoured with the government but also as a symptom of the global bond bubble – Argentina even managed to issue a 100-year government bond (see here). Investors, for the privilege of taking such absurd risk, accepted a paltry yield of 7.9%. The bond price is now down about a quarter and the yield has jumped to 10.3% (when fixed-coupon bond prices fall, yields rise, and vice versa).
In November 2017, I warned about overpriced Argentine stocks – both from the currency and valuation multiple perspectives (see here). Then in May this year, when the peso started plunging, I warned that it was still too early and there was probably more to come (see here).
I’d thought that the peso was overvalued for a while, not least due to my personal experiences of the dollar-equivalent prices of goods and services in Buenos Aires (I’ve lived here for the past decade). A year ago, one US dollar bought 17.40 pesos. I reckoned there was a case for it to trade around 25-27 pesos, meaning a 30-35% fall was on the cards.
At the time of writing, after another two-day peso rout, one dollar now buys 38.20 pesos (according to Bloomberg). That means the peso lost 54% against the dollar over the past 12 months. This looks like an overshoot, but there’s no getting away from the fact that it’s a currency crisis.
Argentina’s president, Mauricio Macri, made a statement last week that was supposed to inspire confidence in markets. He said the government had asked the IMF to bring forward into 2019 credit promised for 2020, ensuring that the country could meet its obligations. Instead, this was interpreted as a sign of weakness and markets panicked.
The central bank hasn’t helped, as it’s sent out confusing signals. One minute it says that the peso is free to float, the next minute it’s intervening heavily to prop it up. Speculators have clearly scented blood.
Of course, the policy makers are between a rock and a hard place. The government has worked hard to bring down bloated government spending. It’s reduced the budget deficit from high single digits when Macri took office to somewhere around 1-2% expected this year.
A large part of that has been the progressive removal of massive, populist subsidies for utility bills and travel on buses and trains. For example, a couple of years ago my monthly electricity bill ran to the equivalent of US$3.50. (It’s now up over 10 times, but still very cheap by international standards.)
The problem is that both higher utility and travel costs feed into just about everything else. Inflation over the year to July was 31%, partly driven by the 47% increase in utilities and fuel costs and 41% increase in transport costs.
On top of that, the international oil price has rocketed to US$70 per barrel, up from US$48 per barrel a year ago. That’s an increase of +46% in dollar terms and (with the peso now at 38.20 per dollar) +220% priced in pesos.
Another hit came from a major drought, which is a big deal in a country where the majority of exports still come from the agricultural sector. This is reckoned to have knocked as much as 1% off 2018’s GDP, and reduced the inflow of much needed export dollars. Compounding this, the dollar price of soybeans – the most important crop – is down 15% over the past year.
Another big problem is the trade deficit, which was US$8.5 billion during 2017, or 1.4% of GDP. Years of penalising the export sector – with high corporate taxes that included (believe it or not) massive export tariffs on agricultural production (grains and meat) – have yet to be fully corrected. As imports (not least of oil and gas, after years of underinvestment) continue to exceed exports, it’s another drain of dollars from the country.
Now it’s all come to a head. Macri’s honeymoon period is clearly over, which also significantly increases the political risks once more. And then there are the massive corruption scandals to contend with as well.
Many of the senior kirchneristas – ministers and functionaries under Cristina Fernandez de Kirchner, the previous president – are either in jail already or under investigation for corruption. Recent developments have blown open a whole new web of bribes under the previous Kirchner governments (Cristina was preceded by her husband Nestor Kirchner). Cristina herself is under investigation in multiple cases.
How much money is involved is unknown. But evidence suggests that 5% of transport subsidies paid to bus and train companies were being kicked back to the people that doled them out. And public works projects were overpriced by around 20%, again with that margin kicked back to the government people that commissioned them. One forensic accounting firm has done a rough estimate, totting up the numbers over many years, and reckons the final tally could run to between US$20 billion and US$35 billion.
No one really knows the extent, or where the money is deposited or buried (according to witnesses, a lot was paid in bags full of crisp, 100 dollar bills). Macri’s government wants to recover the money, and has offered a 10% of sums found to anyone providing crucial evidence.
Despite all of this, Cristina still has a strong, hard-core support base (as does Brazil’s ex-president Lula – leading the Brazilian polls, although already in jail). Polls suggest 30% of voters would still pick her for president.
The rest of the Peronists are split, and Macri’s support is likely to fall further in the circumstances. Never mind that the alternative could have been far worse, with Argentina already well on the road to Venezuelan-style authoritarianism and hyperinflation.
(The last lot had the printing presses running at full tilt to pay for their populist policies and bloated public sector, and achieved an inflation rate in the high 30s / low 40s by 2014. By now, if they’d stayed power, I’m pretty sure the situation would have been far worse.)
Argentina has new elections in October 2019, and the outcome looks increasingly uncertain. Macri’s only hope is for things to settle down, but the latest currency collapse will keep inflation higher for longer. (I previously expected it to fall sharply, once the process of removing subsidies had been completed this year. But now that’s far less likely in the short run.)
At the same time, strikes are becoming more common again (not that they ever really went away). Workers, understandably, want better wage deals to make up for the rising cost of living.
As of now, the university lecturers are on strike and teachers in Buenos Aires province keep threatening the same. A shame for students perhaps, but not an economic problem in the short run. However, the truck drivers union has just threatened a 36 hour strike and the general union council wants a general strike on 25th September. Those things hurt economic activity.
Where does this leave Argentine stocks? Still overpriced, in my view, and with plenty of uncertainty still to come.
The following chart shows the last 25 years of the MSCI Argentina index, priced in US dollars. Note, at the latest price it’s now trading well below 2,000, which takes it back to where it was five years ago.
You can clearly see the massive bull market from 2013 until January this year, when the index went up over four times in dollar terms. This never made sense to me, since until late 2015 it was accompanied by increasingly restrictive and desperate economic policies under the Kirchner government. Afterwards the valuations were so high, in relation to on-the-ground realities, that it still made no sense (even with an optimistic economic outlook).
Now the chickens have come home to roost for investors. Argentine stocks are down 57% since their 18th January peak (in dollar terms). Does that mean they’re now cheap? Probably not…yet.
At the end of July, the MSCI Argentina index had a trailing price-to-earnings (P/E) ratio of 15.8. But it’s a high inflation environment (31% over the past year), so we need to adjust for that. Here’s my thinking on how to do that (roughly).
To start with, we need to take account of six month’s worth of inflation (15.5%). That’s the average inflationary effect on corporate results from the month a year ago and the most recent month. That brings the trailing P/E down to 13.8.
Also, the market fell about 9% during August in peso terms (26% in dollar terms, but the peso fell 19%). Adjusting for that as well brings the estimated P/E down to 12.7.
Next, let’s assume inflation now stays around 30% in the coming year (given the higher prices for imported energy and goods, after the currency collapse). That will add into corporate results over time, so again let’s add 15% to earnings. This gives a rough forward P/E of 11.
Is that good value? Nope. Not with inflation running at 30% and with all the current uncertainty. An earnings yield of just 9% simply isn’t enough. As a reminder, US stocks traded in single digits in the late 70s / early 80s when inflation was in the high teens.
There will be a moment when Argentine stocks will be set up for massive profits. Historically speaking, countries with the weakest currencies in the past year have tended to deliver the very best (dollar) results over the next five years (see here for the evidence across 23 emerging markets and 38 years of data).
But investors should wait for the dust to settle first – perhaps in 3 to 6 months (although only time will tell). Speculators still have Argentina in their sights…but no longer in a good way.
In the meantime – to use a term originally coined by Joel Bowman at International Man – Argentina’s an excellent place for a “crisis vacation”. Local prices, in dollar terms, are down about 40% from this time last year, even accounting for peso price inflation. For the international visitor, this is the cheapest it’s been for many, many years.
But the tree-lined streets of Buenos Aires are still just as pleasant to wander down, the beef is still as tender as before, the Malbec still a pleasant accompaniment. Got time for a tango?