The Daily Update - Steak or fajitas?

In 1824 Argentina issued a bond with a maturity of 46 years, four years later they defaulted; it took 29 years for the standoff with creditors to be resolved. Since then Argentina has defaulted on its debt a further seven times with the last episode back in 2001 which was resolved in 2016, allowing Argentina once again access to the bond markets.

There are a number of positive influences assisting Argentina in the bond market today. Moody’s as recently as March this year changed their outlook to positive from stable highlighting an improved policy stance leading to ‘faster’ economic growth, also JP Morgan, in February this year, included Argentina in their EM local indices bucket; so two favourable factors already over the last few months. Argentina has always been a favourite with other investors as shown by the issues in April last year when they issued $16.5bn in new bonds with interest rumoured, at the time, to be in excess of $70bn.

Argentina has a 4 star rating from our ‘Net Foreign Asset’ scoring system and currently the USD denominated 7.625% maturing in April 2046, with a duration of 11.3 years offers a spread of +450bps over Treasuries. Other investors seem to feel this is great value, and as the four star rating is the same as France, Russia and Canada, fill your boots. Ignore the default risk as that was in the past, surely the 7.5% yield rewards the investor for the risk, or so they seem to think.

We have never held Argentina as the rating agencies still have it at around a B3 rating and so sub-investment grade and also the pricing just does not compensate investors for that rating and the default risks that rating infers. So at a spread of 450bps for the 7.625% bond mentioned above, if this bond were to move to ‘fair value’ it would fall just over 6% or six points in price. According to our relative value model fair value would be over 505bps for this bond and so of no interest for our portfolios.

So let’s compare Argentinan ‘Steak’ to Mexican ‘Fajitas’.

On the surface Mexican debt is just not that exciting, (although Fajitas would work well on this grey Friday morning), until we work the numbers that is. The USD A3 rated United Mexican States 4.6% maturing January 2046 is currently trading at a market price of 94.75, a yield of 4.89% and spread of 188bps. We calculate ‘fair value’ at 136bps which suggests a capital return of over 8% if the bond moved to its fair value price, diametrically opposed to the Argie bond which appears to be everybody’s favourite.

Fajitas win hands down.

‘Buenos tardes’ as we say ‘down Mexican way’.