Ptf Update: Don't cry for me (over) Argentina

Argentina fell under the same thematic umbrella as the positions in Brazil, India and Vietnam; a relatively ‘young’ nation that had moved towards capitalism.

The position was originally a dislocation idea after the election of President Macri in late 2014 ended the long populist (and incompetent, etc.) rule of President Cristina Fernandez de Kirchner.  While President Macri did a fine job of cultivating the low hanging fruit (independent Central Bank, removing capital controls, settling with bond holdouts, etc.), Argentina’s macroeconomic fragility meant he was always walking a fine line.  His government’s management of the more complex reforms was far less impressive, and this combined with the weak macro conditions eventually forced the agreement of a $57bn deal with the IMF in 2018.  This deal provided a much needed capital buffer for the country to stabilize the currency, but came with the IMF’s strict conditions (austerity!) leaving Macri with limited options to boost the economy.   With an election rematch expected in late 2019, and Macri’s position weakening, OM reduced the position size in the first quarter of this year.

The second quarter saw surprises as new political alliances formed; firstly, Mrs. Kirchner decided to run as Vice President inviting her former Chief of Staff, Alberto Fernandez, to lead the ticket.  Then, a third candidate Roberto Lavagna, a former Finance Minister under Mrs. Kirchner’s husband in the early 2000s, formed an alternative option to the polarized Marci-Kirchner battle.  Finally, Macri shocked everyone by naming the Senate Majority (and Opposition) Leader, Miguel Pichetto as his VP candidate!   With all the Presidential tickets announced, Macri’s position improved, Argentinean stocks rallied and OM hung around with his smaller position.

 

However, Macri suffered a huge defeat in the primary polling to get into the general election. Though Macri had no problem getting onto the general election ballot, trailing your opponent by 15 points and doing far worse than even the most pessimistic estimates doesn’t fill people with confidence.   The market’s reaction made clear how little confidence…

Add in an 11% fall in the peso, and the S&P Merval fell 48% on the day; the second largest single day drop globally since 1950!  For comparison, the Dow Jones dropped 22.6% on Black Monday in 1987!   OM managed a pyrrhic victory, with the portfolio’s Argentinean exposure falling a mere ~26% on the day! 

So what now? 

Well, the uncertainty surrounding a Fernandez/Kirchner government makes Argentina uninvestable and hence OM exited his Argentinean positions.  They certainly didn’t help in Q3, though since the start of 2016 Argentina has added ~400 basis points to performance.  As for the future, if Macri should somehow overturn the long and increasing odds to get a second term, then perhaps the situation would be similar to the original dislocation opportunity in 2015.  

The Argentina position was one that’s provided OM with many lessons.  Initially, it helped spur the research that cemented the Dislocation strategies’ rule of typically holding 18-24 months (and 30 months maximum) from the narrative changing event (in this case Macri winning in late-2014).  This time, it served as a reminder that emerging markets are never boring and the downside skew is always worse than you think!  OM would have been better trimming on the IMF deal which reduced Macri’s degrees of freedom and exiting in full back in March.  In both cases, the upside on a Macri victory was so great that missing the first 20-30% wouldn’t matter.  Remind OM of that, if Vietnam, Brazil or India start to go off the rails…


Disclaimer: Our Man held the above positions (GLOB, AGRO, GGAL and DESP) in Argentina.

Ptf Update: Themes – Vietnam, India, and Brazil

Our Man began an update on the thematic positions but it quickly got rather wordy and overly complicated.  Fortunately he stumbled across the below AT Kearney chart, that helped him tie things together more simply.

 
Three of Our Man’s Thematic positions fit the same broad template; relatively young countries that are moving towards capitalism!   Vietnam, Brazil and India all have relatively large millennial cohort (in size and as a % of the population), currently aged 23-27, who are currently entering and driving the work force.

 

Source: AT Kearney

While this is interesting, when combined with an economic move from socialism towards capitalism and supplemented by an attractive long-term chart/technical set-up then OM is interested!  It will not always work, the moves towards capitalism are incremental and these are emerging markets so the absolutes (politics, economics, etc.) are largely in the darker shades of grey.  However, while the move from darkgray to silver is but a modest step away from darkness, the delta - or rate of change - for stock markets is meaningful.  Finally, OM suspects that the technological changes that we are seeing will speed up the process, when compared to historical examples.

Vietnam
One Sentence Thesis:  Young Confucian country following the mercantilist path of predecessors (Korea, Thailand, China, etc.) as it slowly opens to capitalism.
Vietnam is one of the clearest examples of the above traits.  It is following the mercantilist path previously trodden by Asian countries including Korea, Thailand and China, of focusing on securing foreign corporate investment to help develop into a manufacturing hub while slowly opening up to global trade.  While this began last decade, Samsung’s decision to build a second Vietnamese smartphone factory in 2014 helped accelerate the process.  Today Vietnamese subsidiaries are Samsung’s biggest production base responsible for 30% of its revenue, and Samsung represents over 25% of Vietnam’s GDP! 
 

To help solidify its attractiveness within manufacturing supply chains, and secure further foreign investment (such as for Google’s hardware), Vietnam has slowly been opening its markets to trade and moving from Communism to a China-like capitalism/communism hybrid.   Examples include the recent agreement with the EU on a trade deal and an aggressive schedule of privatizations.  Finally, Vietnam has been a beneficiary of the US trade war with China, which has provided further incentive for multinational firms to invest in the country.
 

However, like all things emerging markets this will be a slow and lumpy process. Vietnam is not China; it is size constrained (100mn people) and supply chains take a long time to be built.  Despite this, unless there is a significant change (such as in the trend to becoming a more open economy, or valuations get too crazy, or increased likelihood of a major economic downturn, etc.), Vietnam appears to be in that most virtuous part of circle where the benefits from becoming a manufacturing hub start to spill over into other sectors.  As such, expect it to be to be a 4% to 8% position in the portfolio for a looooooong time, and that the small incremental changes mean that OM will  talk about it far too little!
 

Brazil
One Sentence Thesis:  An economic and market collapse coupled with a massive political/business elite scandal opened the door for unlikely President and his key minister’s Chicago-school economics approach. 

Brazil was originally a dislocation investment and was once the largest investment in the portfolio!   Our Man won’t rehash the entire story for you but the cliff notes are; one of the country's longest and worst recessions, a stock market collapse (80% in USD terms) and a massive corruption scandal the enveloped the ‘elite’ business and political class, all of which culminated in the successful impeachment of President Rousseff.

 
While OM could have managed the dislocation investment better, the 2018 election and the appointment of Paulo Guedes – a Chicago-trained economist – as economic tsar helped confirm Brazil as a thematic investment.  Guedes’ economic plan is what you’d expect from a neoliberal economist – deregulation, privatization and pension reform.  Pension reform is the most important in Brazil; for the last 20-years various forms have been in the works as a necessary component to shoring up the government’s finances and none has succeeded.  However, Brazil’s lower house of National Congress approved a pension reform bill last month, which will now head through committee and the Senate with final approval of the legislation likely in October.

 
The success of pension reform should be a good first step – investment has remained weak in Brazil, with international businesses viewing pension reform as a litmus test of the economic team’s ability to pass its agenda.  OM’s expectation is that successful passage of pension reform will prove a strong first step in restoring the market’s confidence in the economy and the political stability in Brazil.  While Brazil is unlikely to be held for as long as Vietnam, and OM is more sensitive to the medium-term charts/technical picture, it is still likely a multi-year holding in that same 4-8% NAV range.
 
 

India
One Sentence Thesis: Modi’s re-election with another large majority likely means continued steps towards his version of national capitalism and reduced bureaucracy.
Back in 2014, when Narendra Modi swept to power to become Prime Minister of India it was a time when many believed in hope and change for India.  This partially reflected a Modi campaign, and his reputation as Chief Minister of Gujarat, that was focused on economics and cutting bureaucracy.  It also took advantage of a decade of Congress party rule that collapsed under disappointing economic conditions and a multitude of corruption allegations. 

Like all things emerging markets, it wasn’t so simple.  While PM Modi has made strides to reduce bureaucracy, he has also introduced his version of state or national capitalism and in so doing failed to live up to some of the high expectations the market held for him.  However, 2019 saw PM Modi re-elected in a landslide and OM is quite aware that it is often in the second term that the largest economic changes can be made (from US/UK history, think Reagan’s second term or Thatcher post-1983 election victory).  There have already been suggestions of wide-reaching changes to the civil service and we are likely to see further expansions of Modi’s national capitalism.  While much of Modi’s platform and approach is far from perfect, as noted previously investing in emerging markets is often about incremental progress.   Our Man increased the India position in early 2019, as it became clear that Modi was going to comfortably win re-election, and it is in the midst of its 4-8% range.


Disclosure: OM is (obviously) long all of the themes mentioned above.