Argentina's Stock Market: Risky, But A Risk Worth Taking?

Includes: ARGT
by: Discount Fountain

Inflation levels in Argentina have been surging.

The country has recently had to seek financial assistance from the International Monetary Fund.

However, Argentina's stock market was the best performing in the world in 2017.

The index could have further room to rise if economic reforms are successful.

As with any emerging market, investing in Argentinian equities comes with heightened risk.

Argentina's economy is on the edge, but its stock market has been one of the best performing in the world. A combination of high interest rates and soaring inflation has led to significant hardship for businesses, and the country has subsequently had to turn to the International Monetary Fund for financial assistance.

However, Argentina's stock market tells a different story. Since 2012, we see that, after a period of relatively stationary movement, the MERVAL index spiked all the way through to the end of 2017 before seeing a significant drop this year, resulting in a net gain of over 900% over the past six years:

With inflation at 26.40% and interest rates at 40%, the situation from a price standpoint could not look more different to that of developed markets, where inflation is only starting to approach normal levels again - normal being a level below but close to 2 percent over the medium term. The overall goal by the central bank of lowering inflation to a target of 5 percent has been postponed till 2020, with the target for this year having been recently revised up to 15% from the prior 8-12% target.

With persistently higher levels of inflation in Argentina, compared to the United States, we see that the peso has essentially gone nowhere but down against the dollar:

Therefore, while an investor who had invested in the MERVAL over the long term would have seen an over 900% return, there would have also been a nearly 90% loss from exchange rate risk.

In the case of Argentina - as is very often the case with emerging market assets - investors will demand a very high return to compensate them for the heightened risk of investing in emerging markets. The question remains - could potential future gains in Argentina's stock market index entice investors to stick with Argentinian equities?

To answer this question, it is worth examining the main drivers behind Argentina's stellar index performance in the first place. Firstly, in spite of rising inflation, one major thing that Argentina has going for it is relatively low debt levels. For instance, Argentina's government debt to GDP stands at 54.20%, which is still relatively lower than many developed countries. As two examples, the United States has a government debt to GDP of 105.40%, while that of Japan's is the highest in the world at 253%. Corporate debt levels are also low, which has allowed Argentinian companies greater access to loans due to a perceived lower risk by financial institutions.

Moreover, much of the rise in Argentina's stock market has been driven by speculation regarding the impact of economic reforms rather than growth itself. For instance, reforms put forward by President Macri to reduce capital controls imposed by previous governments as well as price controls on food and gasoline made it easier for the country to access foreign capital, and this was a big reason behind the rise of Argentina's stock market last year.

That said, when we look at hard economic growth metrics, we see that 1) consumer spending and GDP growth have remained largely stationary since 2012, and 2) the country's balance of trade has dipped into a deficit, meaning the country now imports more than it exports:

GDP Growth

Balance of Trade

Consumer Spending

Given that we have seen a recent drop in the MERVAL, this may well provide a support for further growth from a price perspective. However, it is my view that a significant part of this will hinge on the extent to which Argentina is successful in combating inflation, and whether capital control reform will ultimately result in a positive trade balance going forward.

To conclude, there may be potential for further upside in the index depending on the speed and strength of recovery in Argentina's economy. That said, let's not forget that Argentina is an emerging market, and with such markets come significantly greater risk and volatility. Going long the MERVAL may prove to be profitable, but it's not for the faint-hearted.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is written on an "as is" basis and without warranty. The content represents my opinion only and in no way constitutes professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.