The Big Idea
Lessons learned from Latin America in 2024
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
The lessons learned from this past year are less about learning from my mistakes and more why my out-of-consensus top picks aligned with top emerging markets outperformers. Year-to-date, that includes returns in Argentina (84%), Province Buenos Aires (106%), Ecuador (70%), El Salvador (32%), the Bahamas (18%) and top ‘BB’ performers including Costa Rica and the breakaway performance of the Dominican Republic relative to Colombia. It was clearly a year for the high yielders, but it was important to avoid default among distressed credits and anticipate the impact of the International Monetary Fund in other places.
There has been much analysis in social media with academic pundits understanding where they went wrong. This is my opportunity to explain why I was right. This is not about the inertia of past policy mistakes but rather the fluidity of unstable equilibriums that eventually force policy reversals, especially under the memory of past policy mistakes. This is relevant for understanding the Bukele reaction function in El Salvador as well as the broader societal and political reaction function across Argentina. These are the credits where there was the most pushback to my bullish views until out-of-consensus last year became consensus views late this year.
Source: Bloomberg
Argentina
My bullish view on Argentina was prior to the runoff general elections and irrespective to the outcome. My Latin America Year Ahead from November 2023 specifically references these reasons:
- The recipe is the same no matter who wins,
- Fiscal adjustment will be forced on the next government since you cannot spend what you cannot borrow,
- Memory of past policy mistakes will avert crossing the red line of fiscal deficit monetization and hyperinflation.
There was a clear rejection of policy heterodoxy even prior to the political transition. This memory of past policy mistakes was a critical driver for the current policy successes including shock therapy versus fiscal gradualism, windfall tax moratorium dollars, slow unwind of foreign exchange controls and maybe an effective framework to attract foreign direct investment inflows.
The consensus pushback to that view was that the society would not tolerate the fiscal austerity. However, this fails to recognize that the political transition reflects the broader societal transition. The fatigue of policy mismanagement was greater than the fatigue of fiscal austerity.
My bullish view only gained conviction under the combination of ideology and pragmatism from the Milei administration that exceeded expectations for effective communication and top-notch technocrat appointments. There are some unique takeaways from the first year of the Milei administration:
- Shock therapy works. Most forget that this was the standard IMF recipe from the 1990s for economic stabilization. If society tolerates the initial shock, then the quick pain can revert to quick economic stabilization. The economy is already staging a recovery in the third quarter this year at 3.9% quarter-over-quarter.
- Fiscal discipline matters. Argentina is the only country in Latin America with a nominal fiscal surplus and the only country in recent memory with the fastest adjustment on converting a 1% of GDP primary deficit in 2023 to a cumulative surplus of 2.1% of GDP in November 2024. This should remain the anchor for economic policy management.
- Outsider politicians may have more flexibility. The anti-establishment backlash provided greater than expected political flexibility with the effective “blame game” against the political establishment to force their cooperation.
- President Milei also benefits from higher autonomy under the stronger framework of the executive branch (decrees, vetoes, etc.).
The memory of crisis hits two opposite ways – investors may penalize bond prices under stigma of past policy management, but this same stigma may also encourage policy makers to avoid past policy mistakes. This dichotomy is extreme from both perspectives in Argentina after decades of economic policy mismanagement. For those that understood that “this time is different,” then this overwhelming market skepticism offered a unique investment opportunity. My initial projection for 12-month returns was for bond yields to retrace back to the 14% exit yields post restructuring that also coincide with the lower 14%-16% range of distressed credits. The outperformance of the past two months exceeded expectations on the onshore inflows from the tax amnesty that may have been the catalyst for sub-12% yields.
El Salvador
My main investment thesis late 2023 was “IMF program as a real option.” The return profile was understandably less after 100% total returns in 2023. However, the primary driver for the 33% year-to-date returns was on the one-two punch of repetitive debt buybacks and IMF program optimism. There has been much back and forth debate on the prospects for an IMF program. This was always my base case view, admittedly under varying conviction levels throughout the past 12 months.
The naysayers maybe didn’t fully appreciate the drivers of the Bukele reaction function. It’s not enough to say that lengthy IMF negotiations reduce the optionality of a final program. The motivations are higher as policy optionality declines. The muddling through isn’t sustainable on still high fiscal deficits and restricted access to credit. If the Bukele administration remains committed to pay, then fiscal discipline (with or without the IMF) is the only viable option after exhausting viable financing resources.
The Bukele administration was unique for successive buyback transactions beginning September 2022 through November 2024. This track record for debt repayment shows not only a higher priority status on prepaying Eurobonds but also the pushback against the implied criticism of default level bond prices. The international opinion matters for a small country that seeks broader international influence and the prestige of credit rating upgrades and normalized bond yields (official tweets of higher bond prices).
These motivations/objectives require broader policy orthodoxy not only for earning the reputation of a well-managed country but also for averting any criticism for policy mismanagement. The commitment to pay bondholders will eventually require the fiscal adjustment necessary to pay bondholders. The second mandate for the Bukele administration has been shifting from a political to an economic agenda. The IMF program is not only to access concessionary loans but also to attract FDI inflows for higher trend growth under the positive vote of confidence of an IMF program. My predictions were for “another tightening of credit spreads maybe even below the 10% yield threshold as markets unwind default risk and benefit from the final phase of alpha return.” Our initial estimates were overly conservative with the curve shifting below 9% yields and bull steepening on the favorable technicals after successive buyback operations.
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