Doug Casey’s Note: In the following article, my Argentine friends spell out the reasons why now should be a good time to speculate in Argentine bonds. There’s an excellent chance they’re right. Recall that it was only in 2017 the Argentine government floated US$2.75 billion of 100-year bonds—and the issue was oversubscribed. Today they trade at less than 50 cents on the dollar. By the time they come due in 2117, I promise they’ll be worth exactly zero. The dollar probably won’t exist, and very possibly neither will the Argentine government in anything like its present form. It just goes to show how Mr. Market goes from the heights of enthusiastic mania to the depths of black depression.
But we’re not looking out 100 years. Right now, Mr. Market is very bearish on Argentina, so it’s a time to look at values here. As you may know, I spend a lot of time in the country, and am very fond of many things about it. My guess is things could get a bit grimmer before they cyclically improve. We’ll see. The point is that now is the time to pay attention, looking for a bottom.
The authors promise that in the months to come they’ll also take a look at Argentine real estate and stocks. You won’t want to miss it.
By F. Clavier and H. Tango
Immersed in a deep stagflation and after receiving the largest rescue package in IMF history, Argentina is at the verge of default for the third time in the 21st century. The previous defaults occurred in 2001 and 2014, although the country kept part of its debt in partial default all the way until 2016. The last two years have been filled with turmoil and uncertainty, but the straw that broke the Camel’s back was the recent presidential election where the Argentine people ousted market-friendly President Mauricio Macri and voted for the return of the Peronists, the left wing populist political movement that has ruled Argentina for most of the past 70 years and is responsible for the downfall of the world’s 9th strongest economy, before World War II, to the train wreck we observe today. Mr. Market has freaked out and is running around Bonzo-Style, driving asset prices into the ground (Argentina stocks are close to 10-year lows and Argentine corporate and public debt are trading at default levels). In the meantime, households and firms are bankrupt and have been for some time now, so all they can do is sit and watch in despair as the country tears itself apart for the millionth time while their savings, jobs and efforts are thrown into the bin like used toilet paper.
Per-capita GDP has dropped 10% over the last decade, which is quite a record… most countries need a war or a natural disaster to see such drops in per-capita incomes. Unemployment has risen to a staggering 10.6%. Economic activity has dropped 3% YTD and annual inflation is at an outrageous level of 55% (the second highest in the world). The official exchange rate has gone from 40 to 62 pesos per dollar in one year, the black market dollar is at 70 pesos per dollar and the exchange rate that companies use to get their money out of the country (by buying capital market assets in Argentina, de-listing them, and re-listing them abroad to sell them) is 80 pesos per dollar. Plus, the cost of needing to virtually reinvent the wheel in order to get their money out.
Regular people are not so lucky though. If they want to change their pesos for dollars in the official market, they can only buy USD 200 per month, and risk of being prosecuted if they exceed that number. That is because the Central Bank’s net reserves are at dangerously low levels with no perspective of dollar inflows in the near future. The Debt/GDP ratio is above 90%, with most of that being short-term debt in US dollars; it’s essentially impossible for the country to honor. There’s a mixture of panic and resignation in the streets.
Our first advice to investors: KEEP CALM AND CARRY ON! Like Baron Rothschild so infamously stated: “The time to buy is when there’s blood in the streets.” Argentina in crisis is like finding your partner cheating on you for the 5th time… it most definitely hurts, but it shouldn’t be surprising. This cycle’s been repeating itself for the past 70 years and, although some people rightly believe that Argentina is the place where money goes to die, the country has proven to deliver great opportunities for those who know how to time it and have the temperance to withstand volatility. Never were Roman poet Virgil’s words more conducive: “Audaces fortuna iuvat” (fortune favors the bold).
First things first: Like the Republican or Democrat parties, or even the PRI in Mexico, Peronism has a broad definition. Elected president Alberto Fernandez himself is not your typical Peronist and has many shades of Grey: He has been involved in politics since 1983. He has worked under the presidencies of non-Peronist Raul Alfonsin and Peronist Carlos Menem, Eduardo Duhalde, Nestor Kirchner and Cristina Kirchner (basically all the presidents from 1983 to this date with the exception of Mauricio Macri and Fernando De La Rua). Don’t be fooled when he expresses anti-market remarks or his supposed defense of Bolivia’s deposed president Evo Morales, his lack of disapproval on Venezuelan dictator Nicolas Maduro, or his “TED talks” with Uruguayan ex-president Pepe Mujica. These are perilous times in Latin America and, until he gains political strength, he needs to indulge his mostly left-wing political constituency; after all, most Argentinians are Peronists (they tend to have an inclination towards socialism, populism and Diego Maradona). Fernandez is a shrewd, pragmatic, un-ideological and, most of all, very experienced politician. He can wink to the left but turn to the right.
Proof of this is that he has already called upon a wide base of businessmen, unionized workers, political parties (even some congressmen from current President Macri’s party have joined Fernandez’ ranks) and social movements to work in generating a national consensus (such as President’s Lula social consensus during his first presidency that catapulted Brazil into an emerging world economic power). Additionally, he has toured Europe and is doing all in his power to start his relationship with president Donald Trump on the right foot. He understands that “the Donald” is a key player for Argentina’s upcoming negotiations with the IMF. Recently, he said they are already engaging in conversations to solve the Argentinian debt issue.
The last hint came recently with the composition of his cabinet. Most of the faces we saw during the press conference are moderate Peronists. Although there were some radicals, which investors came to fear during Mrs. Kirchner’s government, Fernandez is showing ever clearer signs of moderation.
When president Carlos Saul Menem won the presidential elections in 1989, the country was submerged in one of the most violent hyperinflations in history and economic activity was practically wrecked. The markets went berserk… what kind of disaster was this guy from a small northern province, who had been imprisoned from 1976 to 1981 because of his supposed involvement with the radical revolutionary movements of the 70’s, visit upon the country’s economy? President Menem, however, ended up leading the most prosperous economic era since the return of democracy in 1983. Investors and speculators who bought or stood their ground during the first years of his mandate (1989-1991) were poised for the bull market of a lifetime from there onwards and many fortunes were made. Exactly the same thing happened after the 2001 economic debacle and Eduardo Duhalde’s and Nestor Kirchner’s presidencies: investors who stood their ground or went long at that point saw their investments multiplied (with the added benefit of the tailwind generated by the commodity super-cycle that advanced most Latin American countries). We invite you to look at what’s going on in Argentina today and then look at what was going on in 1989 and in 2001… then study what happened right after those crises. History repeats itself, especially in Argentina… over and over again. It all goes back to the basics: there’s a famous quote that states that the 3 secrets for Real Estate investment are: “Location, location, location”, well the 3 secrets for investing in Argentina are: “Timing, timing… and know your history”.
We know quite a bit about both Argentina’s schizophrenic history and the tendency of Mr. Market to overreact to its cyclothymia. All asset classes (stocks, bonds, sovereign debt and real estate) in the country are selling at a discount. Real estate in particular is selling at a more than interesting discount as the crisis is starting to hit individual and corporate liquidity; many need to unload illiquid assets at bargain prices. In the long term this will probably be the most profitable trade. Nonetheless, this is a long-term play, given the fact that capital exchange controls are here to stay. So it will be hard, or at least very expensive, to get large amounts of money out of Argentina.
There might be another, short term and much more liquid, opening surfacing soon which we believe is the best play for a tenacious speculator: a relative value opportunity might be arising in Argentinean sovereign debt, which is trading at default levels already.
Let’s compare the Argentinean dollar sovereign curve (NY Law) before the 2018 sudden stop in Emerging Markets with the one we have after the elections results. We can see how they mirror each other, reflecting a brutal flattening of the fixed income curve:
Credit Default Swaps spreads have skyrocketed, with the 5Yr CDS jumping 1000 Bps after the primary elections’ outcome. This massive increase in risk premium led to a ferocious sell off by panicked debt holders. Additionally, liquidity premiums jumped excessively as the selling activity started to dissipate and buyers vanished. At this point it starts to seem the curve could be mispriced.
On Friday 6th, Columbia University economist Martín Guzmán was named Economy Minister. A young academic (and protégé of Nobel Prize-winning economist Joseph Stiglitz) he is considered to be an expert in the field of debt restructuring. He told delegates at a UN debt management conference last month that Argentina should seek a swift restructuring with private bondholders that should be concluded by March 2020. His plan includes freezing coupon and interest payments over the next two years, as well as pursuing primary fiscal surpluses. This makes us think the negotiations with private bondholders most likely will be directed towards a fast agreement without significant haircuts of principal.
In the following figure we have the historical haircuts in Net Present Value across 124 debt restructuring events between 1970 and 2013, without principal haircuts. The red line represents the “expected” haircut that is currently being priced in Argentina’s sovereign debt curve. There are only 6 cases out of the 124 that actually ended up at this approximately 60% haircut level and they all took place in a very different world (1982-1990).
As we move to the end of the sample, restructuring events become way less numerous and the average haircut becomes smaller. One of the most comparable events of this class is the Uruguayan 2003 “friendly” debt restructuring. The weighted average of the NPV’s haircut in this event was 13% (far less that what is being priced today for Argentina’s debt). Additionally, many members of the actual government are suggesting a “Uruguayan style” solution for the debt crisis.
For these reasons it could be suggested that there may have been an overshooting in the aversion for Argentinean debt. Argentina is dealing with a short-term liquidity problem, but the country is solvent in the long run. That being said, here are two different bonds that you should keep under your radar:
A) Argentina 38, for a more conservative profile
Protected by New York Law, this is a bond that comes from the restructuring event led by Néstor Kirchner and Roberto Lavagna in 2005. It is a multi-coupon bond that was defaulted back in 2014, in the midst of the “Distress Funds scandal” that got the country into technical default by a ruling of NY’s Judge Griesa.
This bond is trading at around 40 cents to the dollar and yielding an outstanding 14% YTM. It was originally issued with a low coupon (3.75%) and long-term amortization. This particular bond is actually not a threat for the country’s liquidity issues. The coupon will switch towards 5.25% in March 2029, starting to amortize principal (5%) in September 2029. A default event on this security seems unlikely; it wouldn’t make sense because it doesn’t affect the current liquidity crisis.
Compared to the rest of the Argentine fixed income spectrum, this bond was one of the least crushed and yet offers an attractive yield with room for capital gains if risk premium recedes.
B) Argentina 28, a bolder move
This bond was issued under New York law as well. This makes it less risky than the Argentina 24, which is under Argentine law. Based on price movements, the market is expecting a higher punishment for bonds under Argentine law. This doesn’t come out of the blue: Local law bonds have been issued under an administrative resolution that makes them vulnerable to a contrary simple resolution or decree that would modify their prospectus. In other words: there’s no legal cost for the country in modifying the conditions of these payments. Therefore, the spread we see between bonds under NY law and Argentine law is justified.
Bearing this in mind, under a scenario where Argentina unilaterally decides not to pay interest on principal for 2 years and extend 5 years the payment of principal in every local law bond, it would be a better option to have Argentina 28 (A2E8) than Argentina 24 (AY24).
A2E8 is currently trading at around 43 cents to the dollar and yielding 22% YTM. This is a very attractive yield for a bond that could end up benefiting from a preferential treatment for NY law bonds if a reasonable debt restructuring is negotiated.
On the downside: The bond is not as liquid as others in the Argentinean fixed income space. This would be a more suitable idea for value investors than for scalpers.
Editor’s Note: Legendary speculator Doug Casey is an expert on finding unique opportunities in overlooked markets.
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