Why I’m buying Mexico and Argentine bonds
Last month I wrote about the possibility of contagion in the emerging markets but since then things seem to have become a little more stable.
No market has blown up and after no signs of contagion investors are cautiously dipping their toes back into the water. It could even be argued that the International Monetary Fund’s (IMF) decision to give Argentina an extra boost was to avoid more bad news spreading elsewhere.
In the meantime in DC they are charging ahead. There is a new Nafta deal and conversations with the EU are on their way to reduce the already very low tariffs amongst the two economic blocks. The big elephant in the room is China, but the move to impose only 10% tariffs instead of the expected 25% bought the markets some time.
However, we believe that President Donald Trump will try to seal a deal with China before the mid-term elections. After all, this is an absolute prerogative of the executive branch, showing some sort of victory on the China front will probably help a lot with the elections.
As for the Fed it has made it very clear that it is on autopilot in its quest to normalize interest rates. We had an increase of a quarter of a point in September, we will get another one in December and most likely three more next year to bring the Fed Funds rate to a level of 3/3.25%.
Unless a rare or unexpected event happens on the growth or inflation front, we don’t see any changes and so its course is set. QE is also slowing winding down and for the most part bond markets absorbed these changes without getting indigestion. Yes, for emerging markets money is more expensive but so far there are not many signs of stress here.
Where do we go from here?
We believe that emerging markets are very cheap but also volatility still remains, so approach it with care and be nimble in case you make a mistake. Equities in particular are over one standard deviation from their normal valuation compared to developed markets.
Bonds are cheap too and could drop further but the liquidity in that market is tricky if you happen to make the wrong move.
We have recommended to buy Mexican equities, particularly the iShare MSCI Mexico ETF (EWW), encouraged by the Nafta deal, a very predictable election and a promising new administration of Andrés Manuel López Obrador. This ETF is up about 4.5% so far this year and has very low volatility.
We also like the Argentina 100 year bond, we believe President Mauricio Macri has a hard job ahead but with the help of the IMF we think that the worst of the crisis is behind us.
For a more tactical allocation, Argentine equity, particularly the banks and the energy sectors, look very attractive. But be ready to turn on a dime if things do not work out as the volatility of the Merval index this year has been brutal.
We also like Brazil. After the elections a new chapter can begin and we do not think that it is priced into the market yet. The shenanigans of former president Lula before the elections kept many investors at bay.
Surprisingly Europe has shown signs of deceleration. The mini crisis in Italy and the noise from Spain has dampened consumer confidence and spending and while the US and Japan’s growth picked up in the third quarter, Europe’s is lagging and it is not very clear why. The European Central Bank still has a very accommodative monetary policy.
In the US we had a very good quarter, with most indices rallying 5% to 7%, and in most cases reaching record highs. The market is expensive but growth and earnings so far have not disappointed the bulls. We like it here and remain long.