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Investment e.Perspective

Current Issue | April 27, 2017

The Emerging Markets Rally: A New Argentina?

By: Brendan O'Sullivan-Hale, MBA, CFA, Senior Investment Strategist & Oxford Investment Fellow


I remember exactly where I was when Argentina last defaulted on its debt. It was December 23, 2001, less than a year after I began my career at Oxford, and I was on a morning train from Brussels to Amsterdam. Passengers all around me had newspapers to their faces – people still read newspapers then – and the headlines screamed in Dutch and Flemish that something major had happened in Argentina. It wasn't until I got to an internet café in Amsterdam that I was able to figure out what the big deal was: the country had defaulted on obligations of approximately $100 billion.

The subsequent 15 years have witnessed a series of economic crises and policy mistakes, countless lawsuits and riveting political drama centered on Cristina Fernandez de Kirchner, a first lady who one-upped her famous predecessor and Broadway musical protagonist by actually becoming president, and a game of cat-and-mouse with creditors that involved the seizure of an Argentine naval vessel in Ghana by an American hedge fund. It took a ruling from the U.S. Supreme Court and a new administration in Buenos Aires to bring about a final settlement with its holdout creditors.

At the time of this writing, Argentina is engaged in a road show to market its return to international capital markets. Within the next week or two, pending a few final legal hurdles, the country will place 10-year bonds yielding eight percent in the hands of yield-hungry investors. "Argentina Set to Fuel Emerging Market Rally," claimed an intemperate Financial News headline on the morning of April 11. "From time to time, the Republic carries out debt-restructuring transactions," reads the rather more sardonic prospectus for the new bonds.

Is it safe to go back into the woods when it comes to emerging markets stocks? As they've rebounded from their January lows, it's certainly tempting to think so. As of March 31, the emerging markets index was up 5.7% year-to-date, making them the best performing segment of global stock markets.

At least part of the rally, which began in earnest at the end of February, is due to short covering, mostly focused on Brazil. Petrobras and Vale both started the year with short interest equivalent to ten days or more of average trading volume. As the price of oil and other commodities started to recover in late January, traders closed out these positions, and closing short positions in a crowded trade pushed market prices sharply higher.

Besides short-covering, there have been some modest fundamental improvements in the emerging markets outlook. While corporate debt levels remain a concern, the latest data coming out of China has been less grim – March showed a surge in Chinese exports. To the extent that the recent commodity price rises are durable, they benefit major commodity producers like Brazil and South Africa. Meanwhile commodity prices remain low enough that they don't pose meaningful headwinds for importers like India.

The biggest gains this year have been in Brazil – whose stock market and currency have both taken off. Besides the rising price of oil, the Brazil investment thesis rests on political reform. In President Dilma Rousseff's political troubles, optimistic investors see the possibility that Rousseff's Worker's Party government could be replaced by a business-friendly center-right administration, as recently happened in Argentina, albeit under less chaotic circumstances.

The evidence that this will happen is scant. At this writing Rousseff faces the possibility of impeachment for manipulation of the federal budget – and by the time you read this we may know the outcome. Her vice president is implicated in the same scandal, and may also be vulnerable to impeachment. The next in line for the presidency has been accused of money laundering. Rousseff has appointed her still-popular predecessor, Luiz Inacio Lula da Silva, as her chief of staff to shield him from prosecution in the Petrobras kickback scandal. There is wisdom in Baron Rothschild's purported maxim to buy when there is blood in the streets, but right now it appears there's more blood to spill.

Today it's hard to make a compelling case for emerging markets as a group. Valuations aren't bad, but their traditional role as a leveraged play on global growth remains impaired by the weak growth outlook. To the extent a rise in commodity prices pushes the emerging markets index higher, it will probably push the still-battered North American natural resources sector higher, faster. The emerging markets outlook may not still warrant outright pessimism, but it pays to be attentive and selective.

The above commentary represent the opinions of the authors as of 4.18.16 and are subject to change at any time due to market or economic conditions or other factors.