Looking for higher yields? This week, we look at short 44 month Argentine Government senior unsecured "Yankee" bonds, which are currently yielding about 8 1/2% to maturity. Yankee bonds refer to bonds denominated in U.S. dollars that are issued by foreign governments, banks or corporations, such as the Neo Materials (NEMFF.PK) Convertible Bonds denominated in U.S. dollars that we wrote about last week.
Argentina was upgraded last year to "B" and noted as "stable" by Standard & Poor's, but more noteworthy is the country's success in reducing its debt levels to about 38% of its GDP, and last October's landslide victory of the recently re-elect President Christina Fernández. It is our opinion that Argentina's current political stability and strong economic performance, as indicated below, results in a significantly better risk vs. reward opportunity than what a quick or cursory glance at the assigned credit ratings for the Argentine government might imply. As a result, we see these short term Argentine Yankee bonds as an intelligent addition to our Investment Growth & Income Portfolio.
While the equity and commodity markets have rallied into positive territory the first month of 2012, uncertainties as to how both Europe and the United States will resolve their debt issues continue to make wealth preservation a top priority for many people seeking income from their investment portfolios. The current very low "safe" U.S. Treasury rates remain significantly below inflation rates, putting American savers in the tenuous position of continuous wealth erosion.Considering that this has been another year of declining equity and property prices, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the Fed's constant printing of more money (to backstop both the U.S. economy, and also that of Europe) leaves one with the stark realization that all these have resulted in a widespread erosion of wealth that will likely continue and perhaps even accelerate until the aforementioned conditions begin to change.
Argentina's Economic Background
Argentina's booming economy has been one of the few bright lights in an otherwise gloomy global financial picture the last few years. But high inflation, a weakness of the Argentine economy for decades, threatens that growth. Last week, it was announced that average salaries in Argentina rose 29.5 percent last year, while revenues kept pace at 30 percent and unemployment dropped to 6.7 percent. Annual inflation was officially reported to be at 9.5%, much less than the over 25 percent that private analysts say may be the true pace of price increases. In Washington, the International Monetary Fund gave Argentina 180 days to restore international credibility to its inflation index, which has been widely discounted since the government intervened and changed its methods in 2007. Argentines are racing uphill all across the economy as inflation shows no signs of easing.
Meanwhile, Argentina's central bank predicted economic growth of 6 percent in 2012, citing efforts to reduce exposure to global financial contagion, increase jobs and keep the economy growing. That compares to the range of between 4.5% and 7.5% growth previously forecast by the central bank for 2012 and follows two consecutive years of 9.2% economic growth. The government is finally taking steps to rein in the rampant inflation that has helped stoke growth in recent years. During 2012, wage negotiations are likely to result in lower raises than those seen last year, and the monetary supply is expected to increase by 26.4%, a lower pace than in 2011, the central bank said. Most of that will be achieved through loans to the private sector. While the global economy is seen slowing this year, Argentina is still expecting a new record of both imports and exports. The country is expected to maintain a trade surplus, although a narrower one than that seen in 2011, the central bank said. During 2012, the central bank expects government debt to fall to 37% of GDP, with a debt of just 12% of GDP owed to private investors. That is down from the 42.2% and 14.1%, respectively, seen in September 2011.
|Debt to GDP||GDP Growth||Foreign Reserves||Foreign Reserves to Outstanding Debt (%)|
|Argentina||39.5% of GDP||9.2% (2011)||$46.5 billion||25%|
|USA||100% of GDP||1.7% (2011)||$140.607 billion||0.9%|
Argentina benefits from rich natural resources, a highly literate population, an export-oriented agricultural sector, and a diversified industrial base. Although one of the world's wealthiest countries 100 years ago, Argentina suffered during most of the 20th century from recurring economic crises, persistent fiscal and current account deficits, high inflation, mounting external debt, and capital flight. Following a long and severe depression, the Argentine economy bottomed out in 2001, with real GDP 18% smaller than in 1998 and almost 60% of Argentines were under the poverty line. Real GDP rebounded to grow by an average 8.5% annually over the subsequent six years, taking advantage of previously idled industrial capacity and labor, an audacious debt restructuring and reduced debt burden, excellent international financial conditions, and expansionary monetary and fiscal policies. Inflation also increased, however, during the administration of President Nestor Kirchner, which responded with price restraints on businesses, as well as export taxes and restraints, and beginning in early 2007, with understating inflation data. Cristina Fernández de Kirchner succeeded her husband as President in late 2007, and the rapid economic growth of previous years began to slow the following year as government policies held back exports and the world economy fell into recession. High economic growth resumed in 2010, and GDP expanded by over 8.5%. Argentina is considered an emerging market by the FTSE Global Equity Index, and is one of the G-20 major economies.
In the absence of major tax reforms, the top individual and corporate tax rates remain at 35 percent. Other taxes include a value-added tax (VAT), a wealth tax, and a tax on financial transactions, with the overall tax burden now at 31.6 percent of total domestic income. Government spending has risen to 37.9 percent of GDP, and the budget deficit hovers around 2 percent of GDP. Public debt amounts to about 50 percent of total domestic output. The trade weighted average tariff rate is 6.2 percent, with more non-tariff barriers imposed in the form of import and export taxes and fees. New import restrictions were imposed on 200 goods in 2011. Hostility toward foreign investment persists, and the government exerts heavy control in the financial sector. For more information on regulated businesses that are operating quite sucessfully in Argentina, please review our recent write up on Transportadora de Gas Del Sur S.A. (TGS).
Argentina's Political Consideration
Argentina recently moved to slow imports into the country and ease the nation's inflationary troubles, requiring Importers to now report and get approval for goods coming into the country through an official agency. Although the move to give government bureaucracy more powers to control and restrict imports has triggered complaints from Argentine business and industry, and from regional trading partners, President Christina Fernández's administration has always argued that the measures are justified because they help "protect national production and Argentine jobs." Given how her popularity has only increased (to 60%) with the latest economic indicators, it bodes well for the near term stability and continuation of the current administration.
The most obvious risk is that of default. The economy has rebounded strongly from the 2009 recession, but the government's continued reliance on expansionary fiscal and monetary policies risks exacerbating already high inflation. The government's challenge is how to keep alive a consumer boom that has been the motor of economic growth while shifting the subsidies bill to consumers. Wage negotiations with unions kick off in February and the government hopes to keep salary rises to around 18 per cent this year. At the same time, it is seeking to curb imports in a bid to keep the 2012 trade surplus in line with last year's $10bn. In any event, Argentina's days of crippling debts totaling 166 percent of its gross domestic product in 2002 appear to be far behind it, as foreign debt was only 14.1 percent of its gross domestic product last year. Given the short term maturity of this bond, we view the inability to satisfy the debt obligation much less of a risk than the risk of a broader geopolitical change and possible emergence of a politically motivated unwillingness to perform.
Argentina's foundations of economic freedom have weakened in light of extensive government intrusion into free markets. Aggravated by corruption and political interference, the lack of judicial independence has severely eroded limits on government. The government regulates prices of electricity, water, and retail-level gas distribution, pressuring companies to fix prices and wages. However, given the currently increasing popularity of President Christina Fernández's administration, the risk of any sudden or unanticipated changes in monetary policy appears to be diminished. Therefore we see the overall risk vs. reward of this short term bond as being very favorable for clients seeking a higher income while minimizing risk.
With so many uncertainties lingering in the US and global equity markets, we believe a high yielding fixed income portfolio that includes diversification in investment instruments (paying either dividends and interest), and in debt issuers (both corporate and sovereign), and in global currencies (both domestic and foreign) might not only spew a high income stream, but it might also lessen one's overall portfolio risk by protecting principle through a much broader diversification than is typically offered to most retail investors.
We believe that these short term, high yielding, Argentine bonds, denominated in U.S. dollars, are a welcome addition to a well diversified fixed income portfolio, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Ratings: not rated
Yield to Maturity: 8.48%
Disclosure: Some Durig Capital clients may already own a position in Argentina government bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.