Is a crisis looming for Argentina?

Argentina startled the markets recently, when the country’s Central Bank raised its main interest rate to 40% and then the President announced a loan request to the International Monetary Fund for a bailout. Axioma’s Equity Risk Monitors[1] picked up a surge in Argentina’s volatility, and we decided to take a deeper look into the country’s market risk (by tapping into Axioma’s suite of products), to provide portfolio managers with a more complete picture of Argentina’s risk.

Argentina’s equity market has plummeted in 2018, as investors’ sentiments changed and emerging markets turned from darling to dud, following the increase in US interest rates and strengthening of the greenback. The cumulative year-to-date return dipped below -15% last week. This stands in stark contrast with last year’s performance, when Argentine stocks rose as investors poured into the Argentine market, many seeking higher returns in a low volatility environment.

We used Axioma’s Portfolio Analytics to delve into the details surrounding Argentina’s surge in risk[2]. Total predicted risk, as measured by the short-horizon fundamental Worldwide model[3], approached 32% in the month of May, but how does this level of risk compare historically?

 

Examining Argentina’s market risk over the past 21 years shows that the current level of risk is—surprisingly—only slightly above the long-term average and still far lower than levels reached around the Argentine economic depression of 1998-2002.

 
A look at the major components of risk shows that it was the Market, Country and Currency risks that drove the increase in Total Risk, while Industry, Style and Specific risks remained relatively low.


Argentina’s extra-market risk remained very close to the long-term average. Extra-market risk represents the return to the Argentina country factor in the Worldwide short-horizon fundamental model, which can also be thought of as its volatility, holding all other factors constant. However, the volatility of the Argentinian peso against the US dollar has skyrocketed far above its average and is getting closer to crisis levels.

Portfolio managers with exposure to Latin American stocks—and Argentine stocks in particular—need to pay close attention to the effect of these stocks on their portfolios. The sharp increase in the country’s risk may mean portfolio volatility has been driven higher (or lower, if they hold an underweight position), and active risk has changed, too. Whether the position is currently worth the added risk should be reassessed. Local investors should also be aware of this heightened level of volatility, as it tends to drive investors out of the market. While this understanding of risk is an essential component in the decision-making process, it may also help a portfolio manager tell his or her story—the importance of which was highlighted recently by Olivier d’Assier.[4]


 [1] You may access Axioma's Equity Risk Monitors here
[2] The portfolio representing Argentina's market was constructed by capitalization-weighting all Argentine stocks in Axioma's Worldwide Model universe.
[3] The base currency is USD.
[4] See more details about the importance of storytelling versus plain reporting in Oliver d'Assier's blog post here.

 

Diana R. Rudean, PhD

As a member of Axioma's Applied Research Team, Diana R. Rudean generates unique insights into risk trends by consolidating and analyzing the vast amount of data on market and portfolio risk maintained by Axioma. Her research helps clients and prospects better understand and adapt to the evolving risk environment.