Emerging Market Bonds - First quarter 2023 review and outlook
The beautiful rhythmic melody of the Argentine tango is nowhere to be heard this week. As markets opened after the shock result of the preliminary presidential polls, there was only the cacophony of panic. Now, after a few days of careful analysis and reflection, we provide you with six important points to take note of as the country moves towards presidential elections in October and beyond.
1. A new president. While the probability of Alberto Fernández ascending to the presidency is now the prevalent scenario, there is still an outside chance for the incumbent Mauricio Macri to make a comeback. It is possible that Sunday’s poll results act as a wake-up call to hesitating, reluctant voters or even those not eligible to take part in primaries (e.g. Argentinians living abroad), who have now seen what a Mr Fernández victory could do to Argentina’s fragile economy.
2. No default, renegotiation of IMF program. This week, Mr Fernández gave a speech saying that he does not “want to default”. He is also on record stating his intention to renegotiate the International Monetary Fund (IMF) program. From his viewpoint, this is sensible, given that most of his policies will probably contradict the IMF program anyway. Apart from the above, he has not presented any meaningful economic program. This is understandable, given that his focus is on the elections and his anti-Macri campaign, which so far is working in his favor. This is a matter of willingness to pay, of course, whereas ability to pay is what arguably matters more in the Argentine case. Nevertheless, this is a divergence from the approach of the previous president Cristina Kirchner.
3. There is time to turn this big ship. During Macri’s term, Argentina piled on a lot of external debt, particularly with the help of people like us – international bondholders. But, this debt is long-term in nature, most of it maturing more than five years from now. There is a lot of short-term debt too, for sure, but that is owed to either the IMF, bilateral and multilateral lenders, or the local investment community (banks and pension funds). The first logical option for a populist leader (assuming, he does go after investors after all) is to deal with the local ones. In parallel, there is room to negotiate with the IMF and other bilateral lenders. In the meanwhile, the new leadership, if it acts prudently, can reap the benefits of the Vaca Muerta shale oil development, additional electricity supplies and, possibly, other sectors of the economy. All that is to make the point that defaulting on the debt to foreigners is not necessarily the first option. Of course, there is then a question of willingness to pay, which is why we believe pragmatism for the new president is key. Mr Fernández proved pragmatic in the past and his recent comments suggest this remains the case.
4. No return to the politics of a Cristina Kirchner presidency. Even though Ms Kirchner is Mr Fernández’s vice presidential candidate, a Mr Fernández presidency is unlikely to be a repeat of Ms Kirchner’s second term and her ultra-leftist policies, which the markets were particularly allergic to. Mr Fernández is known as a more pragmatic politician than Ms Kirchner and was in fact critical of her policies during the latter part of her presidential term. Indeed, in South America, the left is often associated with populism, especially in Argentina’s Peronist doctrine, but we believe starting his term with a market-adverse stance would not be in Mr Fernández’s interests.
5. The effects on corporates in Argentina are uncertain, yet not entirely disheartening. This week, Argentine corporate bonds followed the downward trajectory of sovereign bonds, but the drop was not as severe, outperforming sovereigns, for now. When it comes to the corporate bond landscape, the following points are important to keep in mind:
a. Most Argentine corporates have very little debt. Partly, because they were barred from capital markets until 2015; partly, because they became cautious about having debt themselves. So, there is no viable reason to default, unless the top-down decision is made for them on the government level (i.e. capital controls).
b. Utilities are the exception to the above. They have more leverage than Argentine corporates in general. However, we see little reason for the government to stop servicing the contracts of power producers. Venezuela’s example of social unrest due to shortages of critical goods and services will see to that. The current pace and magnitude of the re-pricing of Argentine bonds (including corporates) is unprecedented, to our knowledge, so the Venezuela analogy is understandable. But we believe the markets have run too far ahead of themselves. To make it clear: Argentina is not Venezuela.
c. Most of the corporate Eurobond issuers have been in operation for many years, some of them for multiple decades and they have lived through all the many economic challenges that Argentina has faced in the past. They still exist and they still do business. In our view, as in other emerging markets, many large corporates are likely to take a no-conflict approach toward any new administration and receive reasonable guardianship in return (i.e. industry regulation/oversight). Therefore, top-down disruptive policies on certain sectors are unlikely, in our view.
6. Long term, tough times ahead; short term, market reaction is overdone. Almost all Argentinian sovereign bonds trade now between 40 and 50 cents on the US dollar, indicating that those who sell now see a default as unavoidable, imminent, and expect far below-average recovery values. To us, Argentinian bond prices do not appear to reflect a balanced outcome of the odds. The fact that bonds fell indiscriminately across the board, by more or less the same magnitude, indicates an inefficient and panicking market – precisely the type of market we understand and know well. Therefore, we will monitor the situation to identify opportunities, and feel comfortable with the positions that we still hold.