The challenges of the transition to a less fragile economy

Of

Martin Polo

Cohen’s chief strategist

The local economy is fragile, this is nothing new. Despite having reached an agreement with the IMF in March and the benefits of a jump in the prices of the raw materials we export, the fundamental of the economy do not rise. A large fiscal deficit financed to a greater extent by monetary issuance, loss of international reserves, exchange controls and rising inflation are a difficult combination to digest when it comes to investing. In this context, any event can trigger instability. This was the case between the beginning of June and the end of July with a crisis that affected all Argentine assets and fueled very negative forecasts for the country’s future. With a profound reconfiguration of the wardrobe and with measures that are not without future costs, tension it has begun to gradually fade since late last month, but not much more. Without substantial measures, fragility will continue to exist and forces us to be cautious in asset selection.

The global context plays

Argentina is no stranger to what is happening in global financial markets in general and emerging markets in particular. It amply explains the trend of foreign currency sovereign bonds. In particular, in the midst of the local currency debt crisis, the international context has only made matters worse as emerging risk rose by 20% between June and July, commodity prices fell by more than 10% and the dollar appreciated globally – especially against the Brazilian real which lost 10% -. At the end of July, the world situation was improving in tandem with the drop in the price of oil, the normalization of supply chains which allowed inflation to be kept under pressure and therefore to improve investor expectations. With the latter, the dollar weakened, commodities rebounded, US bonds improved and dragged down all global and emerging fixed income indices. To the positive surprise of the latest inflation data in the US, the inflation pressure appears to ease and global markets have a lull whose duration will depend on how quickly inflation falls, but without implying that economic activity deepens the trend. a decline that marked in the first two quarters of the year. Against this backdrop, although volatility will be on the agenda, we do not expect major changes in the global environment in the coming months.

The local context defines

Despite the truce we have set for the global scenario, what will define the dynamics of local assets will be the local situation and, more precisely, the government’s ability to contain an extremely fragile economy. During the recent crisis, all assets suffered instability, the main reflection of which was the country risk which rose to almost 3,000 points and an exchange rate gap of over 150%. With the change of Minister of Economy with greater political weight and with the decisive intervention of the BCRA on the weight curve, the tension has eased and this has brought some relief to the evaluations. The debt swap that canceled short-term maturities, the good August Treasury auction and the jump in interest rates were correct measures to contain the crisis, but they do not solve the underlying problem and will even be a factor of instability in 2023. in the midst of the electoral context. The improvement was contained, it broke the dangerous trend it had taken in the middle of the debt race, but not much more: the country risk remains above 2,400 points -1,000 points more than before the crisis – and the differential extended exchange rate parked around 110%, 40 pp more than at the end of May. Achieving persistent improvement in valuations will depend on the consistency and credibility the business team achieves in the next steps. The market expects concrete measures.

Urgency is more important

Undoubtedly, at this point we give low probability of a radical change in the economic program. The most urgent thing for the government is to reverse the trend that the foreign exchange market has established, which forces the BCRA to sell more and more foreign currency and accelerate the devaluation rate. It is not a supply problem, since with the shock in international prices the liquidation of exports has shown excellent dynamism, but it is the demand that pushes the BCRA to have to sacrifice reserves despite greater currency control. Nor is this a problem exclusive to the energy balance, since, although this year has deteriorated significantly this year, the deficit has generalized in the rest of the accounts due to the strong pressure on demand. Considering that in the coming months the supply of agriculture will tend to decrease – as happens every year – stopping this drainage will be essential since international net reserves are at very low levels. While we believe the government will try to avoid a sharp exchange rate adjustment, Given the weakness of external accounts, we recommend currency hedging.

CER and again CER

The jump in the exchange gap was added to the inertia and monetary expansion generated to intervene in the peso market, has given new impetus to inflation which in July and August would mark an average rise of 7% per month and in the rest of the year it would have a floor of no less than 5% per monthyes Even without foreseeing a decent jump in the official exchange rate, our scenario is that it will hardly be able to drop further. Against this backdrop, and with the signals provided by the BCRA to support the CER curve, we recommend having a significant portfolio position in inflation-adjusted instruments, as they appear to be the most profitable.

Interest rates improve

Faced with the inflationary escalation, the BCRA played harder than usual by strongly raising the monetary policy rate and also for the fixed terms that up to 95% annualized. While it seems insufficient to beat inflation in the short term, it is a good alternative for those investors with a very short investment term.

Medium-term actions

Although economic fragility and high country risk represent a heavy burden on local actions, We recommend a position in Argentine equities for investors with a medium to long investment horizon.. We see value in several local companies, with good balance sheets and good prospects considering a global environment with high commodity prices.

That being the case, the challenges of the transition will be those of bring concrete signals to a market hit by recent events. Meanwhile, with the fragile economy, hedging against inflation and against a possible exchange rate adjustment continues to be a priority in defining our portfolios.