argentine illusions

August 24, 2011

The Greek stock market (the Athens Stock Exchange, or Ase) has now reached a 15-year low at 900 points, as the country marches towards formal default. For some time now, a number of commentators, politicians and various forum dwellers have started making comparisons with late 2001 Argentina. The general line is that the Buenos Aires (Merval) index was 200 points when the country defaulted, and reached 500 points within three months. This offered the patient (or intrepid) investor a 150% return before you could say ‘I-am-broke’.

This is an argument to support one of the following: either “if you happen to be in the stock market, and feel possibly creamed at the moment, don’t panic and make the mistake to sell”, or “if you are not holding stock this is the best time to get a bit adventourous and go long; after all, how much lower can the stocks go from here?”.

Both messages, if taken at face value, would contribute to slowing down the rapid market decline. I can see that trying to prop up a collapsing stock market or forecasting happy days in the near future serves the punters’ own agendas, but they are misleading the public.

Since many middle class Greek families are “entrapped” in the falling market, pundits aligning with the ruling Pasok party are quick to claim that there is hope for a quick rebound. Supporters of the opposition, after placing the blame on the current governments amateur approach to the problem, want to put themselves in a position to reap any potential future benefits. A significant number of (probably badly burnt) investors roam unregulated investment fora spreading the same lines, presumably believing that they are looking after their own interests.

But notwithstanding ones intentions, they are blatantly wrong. Greece might be similar to Argentina, but only to the extent that they both found themselves committed to an exchange rate peg that they find hard to support. Pundits are confusing real and nominal returns, or returns denominated in hard or soft currencies. And while small investors might argue that they were ignorant, politicians and commentators should know better.

Merval, Merval$ and the Ase

Merval (in ARS), Merval$ (in USD) and Ase (in EUR) indexes

In the chart above I put forward the Merval index from 2000 to 2005 (in blue). I rebase the index to 100 in November 2001, which is when the final leg of the crisis begun to unfold. This makes it easier to assess the performance as we approach or move away from the crisis. Merval is denominated in Argentinian Pesos (ARS), the local currency. I also chart the Merval$ (in red), which is the same index denominated in USD and rebased at the same point. Before the end of 2001 there a one-to-one fixed exchange rate between the ARS and the USD; for that reason the two charts overlap in the former part of the chart. This peg broke in November 2001, and the ARS rapidly lost three quarters of its value in the next few months; therefore, following the default, the Merval index produced divergent nominal returns for investors in ARS or USD.

It is true that the Merval rebounded in nominal terms, and more than doubled after the country defaulted and the peg to the USD was broken. But investors received cashflows in a worthless currency that was had lost 75% of its purchasing power; the 150% increase is irrelevant. Denominated in USD, the Merval index has a different story to tell: even after Argentina formally defaulted, the market carried on sliding at the same pace, and bottomed out after it had lost another 50% within the next six months. It then took a further year to return to the level it was when the currency peg was broken.

But how does that relate to Greece? I also collected nearly two years’ worth of the Ase index, and rebased them to the same point (as if we are sitting in November 2001) to make some comparisons. For a start, the decline in the two markets looks surprisingly similar, given that they are ten years apart: both have lost two-thirds of their value over the same length of time. For all practical purposes Greece is essentially pegged to the Euro, in the same way Argentina was up to the breaking point. The decision to be made (by Merkozy perhaps?) is whether this peg is to be maintained.

The Argentinian experience suggests a path for both eventualities: Staying within the Eurozone implies that the Ase investor is still a Euro investor, and the USD-based index indicates a further drop by 50% before recovery begins. This means that one should brace themselves for a ride down to 500 points. Leaving Euro for a New Drachma (or some dual currency setup) can cause the index to rebound, if it is denominated in this new heavily devaluated currency. Then the gains are illusional, as the ARS-based index gains were.

Obviously things are much more complex in practice, and the path of Argentina is not going to be followed exactly by every country that defaults. One should hope so, given that Argentina experienced a 10% contraction during 2002 (the year after default was declared), inflation which topped at more than 10% per month, and more than 50% of the population below the poverty line. Argentina only recently re-entered the capital markets; the abundance of agricultural commodities she produces and rising commodity prices kept her at a surplus through the years following default. This was a relief that Greece does not seem to possess. But it gives an indication of where things can go from here, and a message to the punters to keep their mouth shut.


One Response to “argentine illusions”

  1. Anonymous Says:

    I understand that for international investors it is correct and reasonable to compare yield in USD or euros or any other international currency (eg yen, swiss franc, british pound, australian dollar) across stock markets of different countries. But for domestic investors it is a different story. They mostly have to compare between a spectrum of domestic assets: bonds, shares, real estate, bank deposits and i guess shares are the best choice.


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