Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 221

Fear of missing out trumping fear of loss

In the early 20th century, Argentina was one of the world’s wealthiest nations, thanks to an educated workforce and agriculture. But after a litany of economic and financial crises, Latin America’s third largest country is not high on the list of places to invest for Australian investors.

Just three years ago it was being sued by investors, while simultaneously trying to avert its second debt default in a decade. Government ineptitude and volatile commodity prices have conspired to plunge millions of citizens into abject poverty.

A brief history of Argentina’s economic and financial crises is instructive, because while you may initially wonder what this has to do with you, the market’s current attitude to Argentina is vital in understanding where your returns are likely to go.

Impact of disappearing exports

In the 1930’s, Argentina was unable to escape the Great Depression as demand for its commodity exports vaporised. With government budgets plunged into deficit and public-sector workers unpaid, the military staged a coup in 1930 against the country’s democratically elected president.

Thanks to this precedent, and due to frequent economic disruption, more military leaders led the country than civilians throughout the 20th century, and between 1930 and 1983 presidents averaged only two years in office while the minister for economics was replaced annually.

After a brief period of post-war prosperity, in the early 1950s, commodity prices fell again. The nationalistic president Juan Domingo Peron took possession of British-owned railroads causing foreign investment to dry up. When inflation soared to 40%, real wages collapsed, and strikes following the death of Peron’s wife Eva Peron (you may recall the song ‘Don’t Cry for Me Argentina’) caused the country to grind to a halt. The military intervened again.

In the 1970’s the military regime was being begged by the constituency to return Peron from exile to the presidency and thanks to memories of the post war prosperity the generals relented. Peron died the following year.

Unsurprisingly, when the country made a former exotic dancer and Peron’s third wife his successor, several military and para-military factions struggled for control. In 1976, with inflation at 600% military generals staged another coup.

Many readers may recall the invasion of the Falkland Islands, a British colony, in 1982 with Argentina losing the brief war to the British. After the loss and human rights abuses during a war known as the ‘Dirty War’, the military was disgraced and democracy returned to Argentina, seemingly permanently, in the 1980’s.

Political and economic stability don’t go together

But political stability has not lead to economic stability. An expansion of government offices under president Raul Alfonsin, caused public sector wages to grow exponentially. Meanwhile, lax tax collection systems saw only one tenth of 1% of the population of 30 million Argentines paying income taxes. The consequential impact on the government’s budget and foreign investment saw inflation reach an unprecedented 5,000%. With rioters clearing out supermarkets, Alfonsin handed the presidency over to his elected successor, Carlos Menem, almost six months early.

According to many reports, Menem spent the 1990s attracting foreign investment, selling off loss-making state enterprises and cutting import tariffs. Inflation fell to single digits, and Argentina became the International Monetary Fund’s (IMF) poster child for free-market reform.

By the turn of the Millennium and Menem’s departure however, corruption was rife and Asia, Brazil and Russia’s financial crises saw foreign investment flee emerging markets like Argentina. Maintaining Menem’s Peso peg to the US dollar was impossible and, unable to print money, the government borrowed heavily.

In 2001 the country declared the largest sovereign debt default in history and a depression followed. In terms of income, over 50% of Argentines were ‘poor’, as were seven of every 10 Argentine children at the depth of the crisis in 2002.

In 2003, economic growth returned to an average rate of 9% for five years. GDP exceeded pre-crisis levels by 2005, and Argentina resumed repayments on defaulted bonds. By 2010, 93% of bonds were brought out of default through a second debt restructuring. According to most reports, bondholders who participated in the restructuring have been paid punctually and have seen the value of their bonds rise. In 2006 Argentina repaid its IMF loans in full. In 2016 Argentina came out of the default when the new government decided to repay the country's debt, finally paying the full amount owed to litigious hedge funds.

Argentina is a country where economic instability is normal and locals will tell you another ‘crisis’ is underway or on the way. The country however has experienced its best run of growth since the post war boom thanks to high prices for commodities, due largely to demand from China.

Foreign investment returned in 2016, but the Peso has slipped to fresh record lows in recent months as government spending on social welfare programs, current account deficits and printing of new money has again fuelled one of the world’s highest inflation rates at 20% per annum.

Ok, so now you know something about Argentina going back nearly 90 years. What does it have to do with you? Well, just a few months ago Argentina joined Mexico, Ireland and the U.K. in issuing a 100-year bond. Only 12 months after it emerged from its most recent default the bond issued was massively oversubscribed, such is the desire for yield by global investors.

Another default in Argentina?

According to Reuters, Argentina received $9.75 billion in orders for the 100-year bonds and sold $2.75 billion at a final yield of 7.9% with a 7.125% cash coupon. That’s just 5% more than what investors are willing to lend at to the US government.

A reasonable question to ask is: do you think, inflation, higher interest rates or a default might happen in Argentina in the next 100 years? If the answer is yes, and that’s what the history lesson was for, then investors who hold this bond will have to endure capital losses at some point, while receiving a yield that is insufficient to compensate them for the risk.

When share market investors, including Australian investors paying high price to earnings (P/E) ratios of above 18 times, suggest high P/Es are appropriate given low interest rates, they are playing the same relative value game as the Argentinian bond investors. You can only accept paying a very high P/E if you also accept very low prospective returns.

The Argentinian bond issue, which coincides with Ivory Coast and Senegal offering 16-year bonds at 6.25%, Greek 5-year bonds at 4.63%, Iraq 5-year bonds at 6.75% and Ukraine 10-year bonds yielding 7.3%, suggests the market is at it again. It fears missing out more than it fears losing money.

 

Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is for general information only and does not consider the circumstances of any individual.

RELATED ARTICLES

Hedge funds seizing ships – what next?

Less than 1% for 100 years: watch the price risk on long bonds

Bond demand is dumb, dumber and dumbest

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.