The Argentina Siren Song And Where Else It Is Sung

I’m back! After an extended leave of absence I’ve decided to start writing again. 

Let’s start with a story familiar to those that read MM in my first term: Argentina. 

That cute little fella at the top of the page is already back, only a few short years after Macri’s victory put an end to the sordid story of Argentina’s last debt default in 2001.  

I’m not going to get into the economics or the various mistakes made by the current government and the IMF. 

Take a step back and think about how we got here, and the investor psychology required to move headlong back into Argentine debt: 

• October 2015: Mauricio Macri defeats the ruling party-backed Daniel Scioli, putting a non-Peronist government back in power for the first time in a really long time. 
• Macri appoints one of the most technocratic governments in the history of emerging markets. Argentine economists up and down the tri-state area that had sought refuge on Wall Street over the past 15 years came home to work for and support the new government. 
• This new economic team quickly implements a series of orthodox policies and pitches a market friendly reform agenda with the goal of kick starting investment and growth. 
• Macri quickly negotiates an agreement with holdouts from the previous debt default, and issues a ton of bonds to pay them off and fund massive twin deficits 
• Investors rejoice and welcome Argentina back into the loving embrace of EM

None of these really look like mistakes, do they? 

It started off well. The new bonds did well enough that the government was able to issue the famous Argentina century bond in June 2017. Later that year the government won important midterm elections that were seen as an important barometer for Macri’s success, political capital and chances of winning re-election. 

Less than two years later, this is the chart on the Argentina 2021 bond...which traded at 110 in Q3-17:

Those arrows are supposed to end in a skull and crossbones. 

There, you get the idea. That’s what they call a “sudden stop” in emerging markets. That influx of foreign capital has gone to money heaven. It doesn’t come back...the next one to bring capital to Argentina is that bird--which is why we’re already at this stage: 

You can cite a few reasons for the descent from ten points over par to recovery value in less than 24 months. The government failed to deliver on growth, didn’t get pension reform done, there was a drought, low soybean prices, crappy growth in Brazil, USD strength, global manufacturing slowdown, you name it. Sure, maybe a confluence of all those things. 

But let's look back at the initial bullet points. Where did Macri go wrong? 

I’d argue it was in the hiring of a ton of technocrats to run the economic program. 

One can imagine how the conversations went. We’ll pay off Elliott. We’ll float the peso. We’ll institute inflation targeting at the central bank. Investors will love it. They’ll come to us in droves. 

Yep, that’s how it went down. These guys played a siren song for EM investors, and they ate it up. They played every tune that is music to their ears….abolish capital controls, reform, inflation targeting, de-regulation, tax cuts...liquidity….oh yeah baby…

Before you know it, by mid-2018 there is $100bn in debt on the books and the fundamentals are deteriorating. Suddenly the IMF is back in town, an organization that has a favorability rating in Argentina on par with Trump on your average university campus. 

 By 2019 the IMF has stabilized the situation well enough to buy Macri some time ahead of the October election. The economy wheezes along. Do investors take advantage of the opportunity to scale out of Argentine debt, given the poisonous political nature of the government’s economic record--and one that got into bed with the IMF? 

No, instead foreign investors ate it up! This is a list of the top ten holders of the Argentina 2021: 

Same chart for the argentina 2028 (the only one that is reducing is blackrock, and only because they updated their data already): 

Real money was not only holding these bonds, they were buying more. They were convinced Macri was going to win and make them a fortune. Take a look at the country weights of some of these mutual funds: you’ll find one after another is, or was anyway...overweight Argentina. 

They bought into the swan song that the government told them. They succumbed to one of the classic behavioral biases: affinity bias. “These guys are just like us! They say they’ll win the election. We can trust them.”

There is also some confirmation bias there--where investors believed the orthodox path the government had taken was going to work. Why? Because that’s what they taught us in school! And the election?? Well, those Argentines….they know better than to bring the Kirchners back in, right? 

And there is the last big mistake. Can you name one technocratic, dare I say, elitist, candidate that has won an election lately? One might say Macron...but look how that’s turned out. Sank without a trace. 

Yet despite a terrible economic record, a leg shackled to a hated foreign organization and a global trend against orthodox, technocratic politics, foreign investors convinced themselves that Macri was going to win. 

Right until he lost big. 

And that brings us back to what Argentina can teach us about the rest of the world. Where else are investors buying into the swan song? 

• Brazil: sing it to me Captain...pension reform….deregulation….but growth still sucks and the government is still drowning in debt and red tape
• Italy: wait, it is POSITIVE the most popular politician in the country just got heaved out of the government? That is going to make him LESS popular? 
• UK: Maybe Boris can pull it off. Or maybe people still believe he can. 
• United States: I can think of one good scenario going into the 2020 election, but it involves Joe Biden. With the S&P 4% off the highs, investors believe the most beautiful song is still sung by US multinationals. 

This was a big land mine for foreign investors. They stepped on it--not just because they got the story wrong--which happens to everyone. But because they had a few behavioral blind spots that we can all learn from.

@EMInflationista