Argentina is at a crossroads. The country faces a presidential election in October and a second round in November, with a small chance of left‑leaning populists Alberto Fernandez and Cristina Kirchner - as his deputy - gaining power.
While unlikely, this scenario could pave the way for the reintroduction of capital controls, which would pose a risk to the performance of all financial assets and could even lead to another sovereign default.
There are certainly challenges for incumbent President Mauricio Macri's re-election hopes, as on‑the‑ground developments could lead to a vicious cycle of currency weakness, higher inflation and weaker economic performance. The domestic economic equilibrium is currently very fragile. While a recovery in real wages is anticipated and the currency appears to be stabilising, electoral trends or an external shock could undermine these positive developments.
Turbulent economic and political backdrop
While there are some bright spots in the economic landscape, the negatives currently outweigh the positives. A US$57bn support package Argentina has agreed with the International Monetary Fund has brought about a degree of currency stability, while Argentina's current account deficit is projected to fall from 5% last year to 2%.
However, the economy is in a recession, with gross domestic product contracting by 2.6% in 2018 and expected to contract by a further 1% this year. Inflation ended the year at around 47% and recent month‑on‑month inflation prints have been heavily scrutinised. Interest rates remain high at 50%.
October's presidential election will signal whether Argentina is likely to continue on a path of reforms and macroeconomic normalisation or pursue a more populist agenda. Macri's support has taken a hit amid high inflation and a severe economic downturn and his lead in the polls has narrowed, but we still believe a victory for the Fernandez and Kirchner ticket is unlikely. We anticipate markets will rally in the case of an ‘anybody but Cristina' election outcome.
Inflationary trends should moderate, given the recessionary conditions and the free‑floating currency. Wage adjustments and export growth should go some way to supporting consumption and a broader economic recovery. We believe markets have overreacted to the negative trends, driving many asset prices to excessively cheap levels. This could make for an attractive entry point.
Stocks poised to prosper despite uncertainty
Despite the economic and political uncertainty, pockets of opportunity exist for investors capable of conducting rigorous on‑the‑ground research. On our recent research visit to the country, we met with the management teams of several promising investments we believe can weather the potential turbulence ahead. Here are examples of the opportunities on offer.
Loma Negra, Leading cement producer in Argentina. While volumes fell 15% in January, a recovery is expected in the second half of the year. The company has been able to implement price increases to the tune of 75%, in excess of inflation. The coming online of a new cement plant, L'Amali, should help boost profit margins, while the company has a strong balance sheet.
Tenaris, the supplier of steel pipes and related services. Tenaris has limited direct exposure to Argentina, only around 10% of operations. The company is on track to enter the Russian market, which should provide a modest boost to earnings margins. It is generating free cash flow in excess of USD $1 billion per year, which should leave it well placed to increase dividend payments.
Grupo Financiero Galicia and BBVA Francés, banking groups. The banking environment in Argentina is challenging, with weak loan demand and rising delinquencies. However, margins have been resilient in a high interest rate environment, while liquidity is ample. The investment case for Argentinian banks in the case of a Macri electoral win is attractive, given loan‑to‑GDP ratios of 15%.
MercadoLibre, the online marketplace operator and digital provider of financial services. MercadoLibre is a leading provider to both consumers and businesses. It is underpinned by a large profit pool and its base of existing merchants is offsetting the cost of investments to acquire new customers. The company is focused on expanding into new categories and improving logistics. While the company has exposure to Argentina, more than half of its earnings come from Brazil and the Latin American region more broadly.
Oliver Bell, portfolio manager of the T. Rowe Price Frontier Markets Equity Fund