GavekalResearch The Daily

August 14, 2019

Page 1

Lessons From The Argentine Shock

Louis-Vincent Gave
lgave@gavekal.com
Might the reaction to Macri’s loss be
repeated in other markets if political
shocks emerge?
There is a lack of market makers to smooth
price discovery in the event of a shock
A Brazilian client once warned me about investing in Argentina on the basis
that it’s full of Spanish-speaking Italians who think they are English but
are as rude as the French. Following Monday’s horror show, this seems like
good advice. In US dollar terms, the equity benchmark fell -48% in a one-
day move only bested by the Colombo market’s -62% plunge in 1989. Yet
unlike Sri Lanka, Argentina has for decades been a regular destination for
foreign investors. Thus, the -24% drop in long-dated US dollar-denominated
Argentine bonds, a -17% drop in the currency, or the -38% fall in the local
equity index will cause pain for certain macro players and dedicated emerging
market funds. It should also cause us to ponder a number of questions.
1) The reality of political risk: Argentina’s sell-off was sparked by last
weekend’s primary election. Having suffered mistreatment and defaults
over many years, investors have a black and white view of the country.
In “Investing in Argentina” the movie, President Mauricio Macri rides a
white horse and wears a white hat; former President Cristina Fernández
de Kirchener wears the black hat, rides the black horse and is the villain.
Given their track-records, this Manichean view makes sense. But it also
begs the question of whether other markets could be impacted by similar
sentiment? What if Bernie Sanders or Elizabeth Warren stormed the US
Democratic Party primaries? Or what if Boris Johnson fails to deliver
Brexit, allowing in Jeremy Corbyn? Or what if a newly-elected Italian
prime minister Matteo Salvini pushes the European Union to the brink?
2) A dearth of market makers: Before the 2008 crisis a politically-driven
sell-off would see market makers step into the breach. By offering liquidity,
banks and broker-dealers ensured that currencies, sovereign bonds and
broad equity markets kept trading. This was especially true for a high
yielding, rather illiquid market like Argentina. However, the ability of
banks and brokers to step in at times of stress was a casualty of post-2008
reforms. In short, liquidity can dry up faster than people expect.
Checking The Boxes
Our short take on the latest news
Fact Consensus belief Our reaction
Higher than 1.7% expected; CPI Stable inflation in the US; good
US CPI rose 1.8% YoY in July,
ex food & energy rose 2.2%, news for US equities as it allows
from 1.6% in June
from 2.1% more room for the Fed to ease
German ZEW expectations Today's 2Q GDP expected at
Worse than -28.0; lowest since
fell to -44.1 in Aug, from -24.5 -0.1% QoQ; 3Q data points to
Dec 2011
in July technical recession
China industrial value added Below expected 6.0%; seasonal- Underlying trend is of a gradual
rose 4.8% YoY in July, from ly adjusted measure slowed to slowdown albeit with seasonal
6.3% YoY in June 5.9% YoY, from 6.3% volatility
Inflation within target means RBI
India CPI at 3.2% YoY in July, Above 3.1% expected; core CPI
still has room to continue easing
unchanged from June rose 4.1% YoY, from 4.0%
policy to support growth

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 GavekalResearch
It is noteworthy that the Argentine shock
did not spread to other emerging markets
The US dollar remains stuck in the range
Putting it all together might this episode
point to a strong outlook for EMs
The Daily
August 14, 2019
Page 2
3) The limited contagion: Argentina’s face-plant has had limited external
repercussions. Brazil’s equity market is one of the few that is up this month
(in local currency terms) while Chile is down just -2.1% and Colombia
-0.5%. Perhaps even more impressively, the US dollar barely registered
a bump in the face of this EM turbulence. Instead, the dollar remains
range-bound, as it has been for the past nine months or so. On this last
point, it is interesting that in an otherwise “risk-off ” month of August,
which now includes a proper EM blow-up, the dollar hasn’t fared better.
On most recent risk-off days, the US currency has weakened rather than
strengthened. Perhaps this helps explain the limited contagion.
Putting it all together, asset prices tend to be driven by the interaction of three
key prices: the US dollar, US interest rates and oil. Thus, did the Argentine
meltdown just tell us that the risk of a US dollar surge has greatly reduced?
Also, consider that US interest rates—which were thought to be rising just six
months ago—are now falling, and the fact that oil is range-trading at US$50-
US$70/bbl. The suggestion is that the environment for other emerging
markets (those without “black hat” political risk) may not be that bad.
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