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    20180531 LatAm Insight's Mexico and Argentina

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    LatAm Insight's Mexico and Argentina

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    CHIEF INVESTMENT OFFICE LatAm Insights Mar 2018 Dicer teres MEXICAN ELECTIONS UPDATE Andrés Manuel Lopez Obrador holds the lead in voter intentions for the presidential election, slated for July 1st. The second and final debates take place on May 20th and June 12th respectively. Covered in this brief are key dynamics we're focusing on. ARGENTINA UPDATE Irvestors should carefully consider the pros and cons of investing in Argentina, Structural reform aimed at liberalizing and unwinding significant distortions in the economy, may set the stage for long-term growth, if the market agrees to dance to Macti's tango. In Mexico, AMLO Ahead on the Backstretch Mexico is set to hold presidential, Congressional, and local elections on july 1st. There are four leading presidential candidates: + José Antonio Meade of the Institutional Revolutionary Party (PRI) + Ricardo Anaya Cortéz representing “FRENTE”, the center= right coalition made up of te National Action Party (PAN, the Party of the Democratic Revolution (PRD), and the Citizer’s Movement (MC) ‘+ Andres Manuel Lépez Obrador (known as ’AMLO’) of the National Regeneration Movement (MORENA) + Margarita Zavala, an independent and wife of ex-President Felipe Calderén, ‘Akey takeaway is a general desire for populist proposals from the Mexican electorate, according to BofA Merril Lynch Global Research (BofA ML Global Research), AMLO and Anaya, fist and second in the polls (see exhibit 1), have offered more of them than the others. Mast candidates call for significantly ‘aisng the minimum wage while cutting taxes and increasing spending for social programs, proposals that may put pressure on Mexico's finances if not implemented prudently. AMLO is seen as having the mast disruptive platform, calling for reviews of oll contracts—established in the wake of Mexico's liberallzing energy reform—and the new Mexico City International airport currently under construction. He also calls, for establishing a stipend program for qualifying students and the elderly as well as decentralizing the government, reducing its concentration in Mexico City. AMLO REMAINS THE LEADER, WITH LIMITED SIGNS. OF A TURN IN POLITICAL TREND. Exhibit 1: Bloomberg polltracker Mo ip eect eee) eee ss & & & 2 2 Se aeea eM ee cae eee Note eagle nh arg fpasbseden uty. ‘Source lobe Chet nese fice Osa fon tbe 12,2017 toMy § 2018 ‘eine Weal anager es le podets and series fered by Merl yeh Pere Fenner & Sith orga BS Merrill Lynch Investment products (tPF4s),aregistered bce eae and Merb SIPC, and ther subsas of Bako Ameria Corporation Bot Car). Banko America Capoaion Teen rk Gearateed May Lose Vale Locals have expressed increased confidence that AMLO will win the election. Indeed BofA ML Global Research paints out that in contrast to his 2006 presidential campaign, when he was ahead in the polls early on, his lead at this late stage of the campaign has remained relatively stable. A factor behind this dynamic may be that until recently the Anaya and Meade ‘campaigns had been at loggetheads, benefiting AMLO due to lack of focus on his proposals, In particular, Anaya’s, ‘momentum has been dented by accusations by the ruling PRI regarding the lack of probity of a property deal Anaya was Involved in during 2016. ‘The frst of three presidential debates was held on April 22nd. While a majority declared Anaya the winner, the debate was not a garne-changer. Nonetheless a poll released by Parametria on May 3rd has seen AMLO's lead narrow from 18 points to 14, Anaya has gained, while Meade has lost support. ‘The result has been seen by some as Anaya emerging as @ Clearer head-to-head contender against AMLO. Looking ahead, the second and final debates are to be held ‘on May 20th and June 12th, Key questions include whether Meade and Anaya will continue thelr evolving strategies, seen Inthe first debate, in which they began to attack AMLO more forcefully. Would this lead AMLO to shift more towards the left, to differentiate himself from the establishment? Does the emergence of Anaya as a clear contender to AMLO boast his appeal, as some of the anti-AMLO vote allocated for Meade switches over? Additionally, is a successful negotiation of the North American Free Trade Agreement seen as a win for the establishment? Does a weakening peso spook the Mexican populace and serve as a headwind against AMLO? {is important to note that there are Congressional and local elections taking place as well, which may shape the political latitude afforded to the winner of the presidental election. The entire Chamber of Deputies (500 members) and Senate (128 constituents) will be elected, Citing Parametria’s poll, for the Former chamber MORENA is ahead with 259 support versus 1996 for the PAN, while for the Senate, voting intentions ‘are 25% and 21%, respectively. Also on watch is political maneuvering between the political partes after the vote. OTHER LATAM ELECTIONS +The first round of Colombia's presidential election is slated for May 27th, with the second round taking place (on June 17th if necessary. As of May 3rd, the business- friendly candidate Ivan Duque is leading polls measuring voter intentions. +The first round of Brazil's general election is set for October 7th of this year, with a second round on October 28th if necessary, Argentina Update: Will It Take Two to Tango? Until recently, markets and Mauricio Macri together had mastered the tango. His surprise victory in Argentina's presidential ballot on November 22, 2015 and his administrations commitment to structural reforms made the Country 2 LatAm darling for frontier market and risk-minded investors. Markets enthusiastically joined him to dance: Since the last major bottom for the S&P 500, which occurred on February 11, 2016, Argentina's Merval Index outperformed it, appreciating 136% versus 61% in US, dollar terms through January 31, 2018, However, the volatlity that has ensued signals the market has become an impatient partner, with a decline of 26% versus nearly 6% respectively from February through May 4th (see Exhibit 1), Argentina's large current and fiscal account deficits have rendered it vulnerable to aggravated Investor sentiment and rising global interest rates. Sentiment has been hurt by worries over the future direction ‘of US. trade policy, while the US. 10-year Treasury yield, a benchmark for global interest rates, has recently flirted with 34%, its highest level since 2013, —— Exhibit 1: Until recently, Macri and the matket were dancing, ‘a great tango as ‘coc he nese fe safe 206th A208 Yc ‘Reset nine Pe prmancen anette es MAY WE HAVE THIS DANCE? ‘The Macri administration has focused on reforms to attract investment and boost the economy's long-term potential growth rate. The settlement with contentious bond-holders. following Argentina's 2001 sovereign default alowed the Country to tap into international capital markets in April 2016 after @ roughly 15-year absence, Meare, agricultural export and certain non-transparent import restrictions were eliminated, helping to ease trade, The ending of foreign exchange contro's seeks to lift investor confidence by increasing the flexibility of investing in Argentine assets, raising their appeal. Approved standards for the systematic withdrawal of subsidies for pubic services, such as utltls, and for reducing the rate of growth of pension benefits strive ta reduce government spending. Improving the fiscal deficit Meanwhile, according to the Center for Strategic and International Studies (CSIS) and Emst and Young, reform aimed at reducing inefficient taxes would helo lower the country’s corporate tax rate from 35% in 2017 to 2596 in 2020. ‘Measures to strengthen Argentina's institutions Include decrees passed to raise transparency in legal cases involving government officials and to extend criminal prosecution to corporations, instead of only individuals, according to CSIS, ‘The latter step may incentivize enterprises to strengthen ‘compliance and with It the rule of law. According to the International Monetary Fund (IMF), Argentina's efforts to systemically transform its economy have yielded notable fiscal savings and laid the foundation for stronger private sector investment in the coming years, Spurred by Improving global growth in the first half of the year, Argentina's economy exited recession in the third quarter, ‘of 2016. Private consumption and investment took the lead from exports and government spending as the main drivers of the recovery as it progressed into 2017. Alongside job creation, real wage growth increased, helped by a peak in Inflation in mid-2016. Investment picked up on 2 rebound in construction activity while improving domestic demand led toa surge in capital goods Imports. In the fourth quarter of 2017, year-over-year growth in real gross domestic product (GDP), at just under 4%, reached its Fastest level since the third quarter of 2015, ‘As a frontier market country in the midst of reform, rsk- minded investors were eager to dance, sending a flood of international capital into the county. In addition to robust equity performance, optimism was highlighted in june 2017 wien Argentina successfully Issued “century bonds,” maturing in 100 years, or 2117, which amounted to a powerful vote of confidence by investors. On October 22, 2017 Argentina held mid-term elections, which were seen by some as an implicit electoral vote of confidence towards Macri and his pro-business “Cambiemas' (Let's Change) political coalition. A positive overall showing by Cambiemos and a distant second place by the populist ex-president Cristina Fernandez de Kirchner in Buenos Aires, home to almost 40% of Argentine voters, lowered investor fears ofa potential repudiation of Macr's pro-business polices and of the start ofa political comeback by Kitchner. Despite Macr’s center-right coalition still holding a minority position in bath houses of Congress, the vote was seen as a refreshed mandate. Macri promised further reform in taxes and labor, among other areas. MACRI'S “GRADUALIST" APPROACH HAS LED TO BUILDING IMBALANCES... ‘Macti has adopted a “gradualist” approach in reforming, ‘Argentina's economy, arguing that “they ask us for a shock ‘adjustment, and to them I say we came here to reduce poverty ‘and make sure that no Argentine goes hungry" Violent protest. that rocked Buenos Aires during the passage of pension reform late last year as well as recent sagging poll numbers Underscore Macr's preference for a piecemeal strategy. However, pursult of tis path has led to building imbalances, LL Capital inflows sparked by investor optimism led to demand for the Argentine peso, keeping its value sustained, despite Continued inflation, which led to a real appreciation of the exchange rate. Rising domestic demand, alongside this evelopment, has resulted in a yawning current account deficit, which the IMF expects to rise from 2.79% in 2015 to 5.1% in 2018, The organization has noted that witle Macris progressive approach has helped smooth the near-term negative impact of fiscal consolidation on the economy, it has meant a stll-sizable fiscal deficit, which has led to notable increases in public debt. Complicating matters has been that much of the debt is dollarized and will require external Financing down the line (See Exhibit 2). Macr's reform strategy has been criticized by the IMF, which has argued for a more aggressive decline in the federal government's fiscal deficit. Exhibit 2:A large segment of the Federal debt is in hard currency Wovenratsinngeress Ml Dewan fees cneey s a 2008 ovo “aors "2012 "2013 "2014" a0ns "2ore “2017 Sere MF Mister de Hong etna Oat f Date 29,217 WHICH HAVE RECENTLY MADE THE MARKET A JITTERY DANCE PARTNER. On December 28, 2017, Argentina's Treasury announced & delay of one year—from 2019 to 2020—in its bid to bring inflation down to $9. This meant a rise in the 2018 inflation target of the central bank, known as the BCRA, from 89-10% to 15%, The move largely reflected a shift to ceality. Annual brice growth in 2017, at 24.8%, was significantly overshooting the official target band of 12%~1796, The development played 2 role in a nudging of inflation expectations higher, which ‘accelerated in January after two cuts to the policy rate by the BCRA These cuts shifted the market's perception, rlsing doubts that the Macri administration would stem inflation in favor of looser monetary policy to ald economic growth (see Exhibit 3). In February, global financial market volatility erupted, partly due to rising uncertainty regarding US. monetary ‘and trade policies. Meare, in Argentina the government announced that it was scaling back labor reform amid pressure from union leaders, while the truckers’ union held a strike, with a promise of more if economic reforms continued, Exhibit 3: Argentina's inflation expectations have marched higher, especialy in 2018, entegpect0'8 | enngoea019 oe. ‘ocd Aa fat) PiRPEETTL: Se aro Conall Republica ge, Osta a of A201, a Since then, the market has fallen dangerously out of step, Rising inflation in March forced the BCRA to sharpen its thetoric and intervene in the forelgn exchange market. On ‘April 25th it spent a record $1.5 billion to contain weakness in ‘the peso, which has depreciated almost 15% this year through May 4th. Worries then focused on the lack of sustainability Of continued intervention, given dwindling Foreign exchange eserves at the BCRA, which totaled roughly a net $31 billion, after accounting for short-term debt, according to BofA Merril Lynch Global Research (BofA ML Global Research) ‘Worsened sentiment has obligated the BCRA and the Mact akiministration to respond forcefully ina bd to reassert, credibly. During the frst week of May, the central bank rasticaly tightened monetary policy raising Its policy interest rate three times by 12.75% over a span of 8 days to 40%. Meanwhile the governments Treasury minister, Nicokis Dujowne, has announced a shit towards further austerity cutting the 2018 deficit target from 3.2% to 2.7% of GDR. in a bid to reassure markets ofthe government’ commitment to ref, CONCLUSION Investors considering allocations to Argentina should carefully weigh the pros and cons, Argentina, as a frontier ‘market, may be inherently riskier than developed and many a ‘emerging markets. A positive is that economic growth remains resilient, even in the face of past fiscal consolidation from the government. Many believe that recent midterm elections have helped strengthen President Macr’s mandate to continue structural reform, bolstering expansion of the economy and its long-term potential growth rate, Recent measures ‘announced by the Macri administration and the monetary authorities to cantain the fallout from increasingly volatile ‘markets have been more coordinated and orthodox, helping improve sentiment, according to BofA ML Glabai Research, However, wilt take two to tango? The market's continued commitment to Mact' lead may be crucial, and it may became more difficult to maintain if the market remains ‘worried aver the impact of the spike in interest rates and greater fiscal austerity on business and consumer confidence, as well as economic growth. The market may also worry over factors outside of Argentina's control, such as continued Uncertainty in US/China trade relations or the prospect of a quicker than anticipated rise in global interest rates. A jittery ‘market may undermine near-term economic growth, raising political pressure on Macr to dilute or freeze his pro-business campaign, abruptly and prematurely ending the dance, lo REPORTS «vestmen nsiehts Markets in Review Een Total Returns In USD (2) Gen Price Lev GD VID Year Levels) Canrent_s@-end_Yeorend_ year go Taian 7653056 20 128 Gran 103 Se 93,1036 _—— 1a ras 20523-8528 58 Hexin 10 138735188 738 Theses SA aero elgg Golan 103 ars 6a 622 Colon 71067428354 Ghiean iy 455455455 398 Chie 0823 1s 02 53 erin 107 524483 517 568 Peru 18336 Ws 505 tums (= Novel Careny-bsed QT YT Year East rao esis) g eel Debt a7 peas eweMER Gig esesos oraz eas Soran 28 41 12 EM Aggregate oedeariom ceca cidade EM Corporate ol 2 16 int DewiopesWariets 203121803126 SP 500 + Commodities Europe 3062203 Total Returns 6 USD (3) me" es anna 737400 199, as estaag ee 30655 7 7 Levels per US0 Curent _10

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