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Authored by Rob Marstrand via OfWealth.com,

Argentina is slowly on the mend. But, after seven decades since Peronism first reared its ugly head, there’s a hell of a lot to fix. I’ve lived in Buenos Aires for nearly 10 years, and have long felt that optimistic investors got ahead of themselves in Argentina. With the peso down 13% against the US dollar in the past 13 days, there’s finally been a wake-up call.

In late 2015, Argentines narrowly voted to replace the government of Cristina Fernandez de Kirchner with one headed by President Mauricio Macri. At the time, consumer price inflation was running around 45% a year (by my own estimate – the official rate was about 11% and a complete lie).

Macri inherited a financial and economic mess. But it’s nothing compared to where the country would be if a couple of percent of voters had swung the other way in 2015. We’d be well on the road to Venezuela by now.

The new government moved swiftly to fix as much as possible. But his ruling Cambiemos block (“Let’s change”) is a coalition of three parties with a minority in both houses of Congress.

So Macri needed, and still needs, to work with the (mostly non-kirchnerista but still Peronist) opposition to build consensus. Given his weak position, he’s achieved a great deal…but much remains.

So much was, and is, messed up in Argentina it’s difficult to know where to start. But I’ll give you one simple example, by way of illustration. By late 2015, my heavily subsidised monthly electricity bill ran to the equivalent of just US$3.50. My latest bill was about US$40, up over 11 times.

That’s still cheap, but it’s a big change. The poorest households still get the full subsidies and the wealthy don’t care. But the lower middle classes are (we’re told) feeling the squeeze, along with inflation that remains high in general (last year it was about 23%, and expected to fall to the high teens this year).

The utility hikes are a hot political issue. The opposition is in the process of agreeing a bill to stop further increases. The president says he will veto it.

That could bring the rent-a-mob protestors out onto the streets. Back in December, the government pushed through a sensible pension reform bill that linked future payments to rises in wages and prices.

In response, thousands of protestors rioted outside the Congress building on two occasions, utterly destroying the square in the process (which had just been completely renovated). Argentina continues to have a fragile social structure and political consensus. The remaining kirchneristas and the hard left are quick to exploit this when they can.

Despite the realities on the ground, investors got way ahead of themselves, especially when it comes to Argentine stocks. I’ve long been saying that there’s far more mess to sort out than most people seem to realise (see here and here).

(Argentine Pesos (blue/black above) per USDollar – not ethe fake smooth line before late 2015, which was the artificial, official rate)

Issues included an overvalued peso and absurdly overpriced stock market. At the end of March, the MSCI Argentina index had a price-to-earnings ratio (P/E) of 20 and dividend yield of just 1.9%. In my view, it’s insane to trust in such valuations in a country with inflation still running above 20% a year, let alone all the other problems. More on that below…

Now don’t get me wrong, there’s plenty of good news. Macri’s gradual reforms have been bearing fruit. For example, the economy looks set to grow 2-3% this year (or, at least, it did until recently).

Car sales are booming, and at record highs (not least since sales taxes have been cut). Tax receipts are growing 5-6% above inflation, as the economy grows and more activity is registered, which helps to cut the budget deficit (expected to be around 3% this year).

Inflation is falling, although more slowly than the government hoped (although it should drop off sharply in the second half, after the big utility bill hikes are finished). Unemployment is falling too, and moves are afoot to bring more workers into the formal sector (currently, about a third of employees work off the books, for cash in hand).

But there are genuine reasons for ongoing concern. The principle one is the huge current account deficit. Based on the fourth quarter of 2017, this is running around 5% a year, with no sign of shrinking. This makes the country reliant on capital inflows to keep the accounts in balance. To solve it, Argentina desperately needs to reduce imports and increase exports.

On the import side, a large part of the problem is a big energy deficit (the country has significant energy resources, but has lacked investment). As for exports, punitive corporate taxation still makes companies uncompetitive in foreign markets (although this should improve over time).

Another problem is a tiny and dysfunctional financial sector, a legacy of decades of crisis and uncertainty. For example, the market capitalisation of the Argentine stock market was just US$101 billion at the end of March, or 16% of GDP. In neighbouring Brazil the market is 11 times as big and 52% of GDP. In Chile, it’s three times as big and 108% of GDP.

This makes the Argentine stock market highly sensitive to global capital flows. When it’s hot, it goes through the roof. The minute it isn’t, it crashes.

Let’s get back to what’s happened recently. As I mentioned before, the Argentine peso has plummeted 13% in the past 13 days (to 8th May). On 25th April one US dollar would buy 20.26 pesos. Now it buys 23.20 pesos, at the time of writing.

The central bank’s response was to jack up short-term interest rates. Until very recently these were kicking around 27%. Now they’re at 40%. This appeared to stop the peso slide on Monday. But, come Tuesday, the peso was down another 5%.

Currency speculators have scented blood…or investors are running for the hills…or Argentines are desperately trying to dump their surplus pesos and switch to US dollars (the haven of choice in these parts). Certainly, there’s been enough breathless, local media coverage that you’d expect the locals to be concerned.

[BREAKING NEWS: As I type, it’s been reported that the government is in talks to secure a US$30 billion credit facility from the IMF. This is a useful backstop, but it’s going to be a seriously hot potato on the political front. The kirchneristas / hard left absolutely detest everything about the IMF.]

Some of the international media coverage has suggested that this could be a re-run of 2001/2002. That was when the suddenly-unpegged peso lost about two-thirds against the US dollar and the country had a massive debt default.

That’s absurd. We’re still a long way from that. But it doesn’t mean Argentine stocks are attractive right now, so let’s turn to those.

Investing in Argentine stocks

There are a couple of ETFs that offer easy access to Argentine stocks, both tracking the MSCI All Argentina 25/50 index. They’re the Global X MSCI Argentina ETF (NYSE:ARGT) and iShares MSCI Argentina and Global Exposure ETF (BATS:AGT).

Although both track the same index, the fund providers give different valuation ratios (illustrating a common problem with ETFs…unreliable data). ARGT is meant to have a P/E of 24.5 whereas AGT reports 27.1. Either way, it’s a high number for such a macro environment.

The index has large exposure to a couple of stocks with close links to Argentina, but whose fortunes aren’t really linked to Argentina. These are Mercado Libre (NASDAQ:MELI), a sort of mini-Amazon for Latin America (although MELI tends to make a decent profit), and Tenaris (NYSE:TS), a producer of specialist steel pipes for the global oil & gas industry.

MELI is from Argentina but makes most of its money elsewhere, and Tenaris has joint Italian-Argentine heritage and makes almost all its money somewhere else. MELI is 23% of the index and Tenaris is 14%.

After those two, Argentine banks make up 23%, and the rest is spread across many industries. The banks are growing fast, but make most of their earnings in depreciating pesos.

Also, they currently enjoy absurdly high net interest margins (NIMs), being the difference between what they receive from loans and pay on deposits. I looked at one bank and estimate that, during 2017, it received 24% on loans and paid average 7% on deposits (note: that’s 16 points below inflation!), giving a NIM of 17%.

(A couple of weeks ago – before the rate hikes – I received a “special offer” from my bank on a personal loan at 32% interest. I declined…)

But those NIMs are set to plummet in future. On the one hand – barring short-term issues – if inflation keeps falling then so will interest rates, meaning lending rates will come down.

On the other hand, if banks want to keep up a high rate of growth in their loan books (the bank I looked at was up about 25% last year in dollar terms) then they’ll need to pay higher rates on customer deposits, in order to attract more funding. In the banking world, you can’t lend if you can’t fund.

As it is, most Argentines would rather sit on physical 100 dollar bills than get a sub-inflation return (especially after income taxes) on devaluing peso deposits.

Argentine stocks continue to be way overpriced, and the index ETFs are not attractive entry vehicles…being a combination of a pricey tech stock, a pipe company, overpriced banks and a general bunch of peso-denominated earnings.

If anything, this is a stock pickers’ market. But I haven’t yet found a stock worth picking, given all the ongoing macro issues.

Argentina is slowly on the mend…politics permitting. In fact, I remain mildly optimistic about the trajectory of the economy…and even the politics. But the recent peso plunge was overdue.

Hopefully, the headlines around the world have been a wake-up call for over-optimistic investors. I continue to recommend that investors steer clear of Argentine stocks, at least until they’re a lot cheaper. About 50% cheaper should do the trick…

In the meantime, I suggest you come and visit this beautiful country. International flights are a lot cheaper than before, as the protected market is opened up to competition. And, with the peso down, the excellent local Malbec and steaks just got cheaper.

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“There is a reason so many investors are increasingly becoming workaholics,” warns former FX trader and fund manager Richard Breslow, “we are operating in a world where feelings always run high and ideas instantly become ideologies. Yet, no one really seems to believe in much of anything. “

In other words, the world is changing faster than ever – don’t marry your biases.

If there is one thing every young trader should be schooled in is the understanding that, “If you snooze, you lose.”

As Breslow notes,

“Go away for a few days and it has become almost a parlor trick to be able to guess where markets will be…

And the worst mistake you can make in trying to pull that off is following the news, but not the price action, while away.

Which of course raises the question what is one to do, short of simply becoming a day trader?

Via Bloomberg,

My first reaction was to deal with it by being grumpy and cynical. That was short-term palliative but not ultimately lucrative. Although any desire for a return to full-on QE, with the mindlessness of front-running forward guidance, was resisted without effort. I’m hoping this is a transitional phase rather than a really unacceptable new normal.

So, fickleness is cheating me out of positioning for the long term based on the news. Can’t keep up with the text-readers who have direct links to the exchanges in trying to dance to headlines. And most unnerving of all, my beloved moving averages are not returning the affection. There are many things I can live without in this life, but Fibonacci isn’t one of them. Especially when I harbor the suspicion that he ran off with my horizontal lines.

Fortunately, necessity is the mother of invention. Plan B, or is it C, D or E, is to rely on two measures I never liked nor had much faith in. I guess they existed all this time for a reason. And it is their moment. But if keeping my head above water in these wacky times requires using some things new, I have also dusted off an old-time favorite. Letting other people do the heavy lifting for me. And for that, I am much appreciative.

Never has the weight of positioning been more impactful on where things go. Both in the build-up and the washout. I used to say that it didn’t matter if a trade was crowded if it was right. That is no longer true. It always matters.

The markets can simply no longer provide the liquidity. Nor does the private sector feel the responsibility to do so. But the trick is to spread your net far and wide in tallying up just what you think are the sizes of those crowded or deserted trades. CFTC data is only one imperfect measure that gets too much attention. But fortunately we have the BIS, IMF, World Bank and the like feeding us information like crazy. And so do many banks. You just need to dig it out, because the packaging isn’t necessarily done for everyone’s convenience. The other factor to remember is that the definition of “crowded” varies very much by asset class.

Rates and Bonds at extremes…

Net USD Shorts starting to drop from extremes…

My other new friend is the hammer. Nothing smashes a trend quite like a technical pattern that screams irrational exuberance. Oscar Wilde was wrong. In this case the cynic, or at least the well-compensated one, gets to learn the value of everything and realizes that it is the price that is irrelevant.

And lastly, all this position building and in your face price action can take place through someone else’s efforts. You get the opportunity to wait for the set-up and take the good risk/return reward.

What does this all mean? For traders, trends both go viral and are viral. You just have to choose which half of that definition you want to try to bank. It’s really hard to have both. Especially if you plan on taking that vacation.

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Authored by Steve H. Hanke of the Johns Hopkins University. Follow him on Twitter @Steve_Hanke.

The Grim Reaper has taken his scythe to the Iranian rial (see chart below). The Islamic Republic of Iran remains in the ever-tightening grip of an economic death spiral. The economy is ever-vulnerable because of problems created by the last Shah, and added to massively by the theocratic regime. Indeed, the economy is more vulnerable to both internal and external shocks than ever. That vulnerability will become more apparent in the face of President Trump’s tearing up of the Joint Comprehensive Plan of Action (JCPOA), and the laying on of more primary and secondary sanctions against Iran.

How fast the death spiral will spin is anyone’s guess.

The most important price in an economy is the exchange rate between the local currency and the world’s reserve currency — the U.S. dollar.  

[ZH: In fact, the Rial traded at 85,000 Rials per dollar late last night…]

In Iran, the IRR/USD exchange rate, represents the most important price. By using active and available black-market (read: free market) data for the Iranian rial, I have transformed the black-market exchange rate into accurate measurements of country wide inflation. The economic principle of Purchasing Power Parity (PPP) allows for this reliable transformation, so long as the annual inflation rate exceeds 25%.  

The chart below shows how Iran’s implied annual inflation rate has surged to an annual rate of 75.8% with the collapse of the rial’s value against the U.S. dollar. Indeed inflation has spiked in 2018.

So, what is to come of Iran’s economic death spiral? It can be summed up in one word: misery.

To get a sense of how miserable Iran is, we can look to Hanke’s Annual Misery Index. Back in February when the index was calculated, Iran ranked the 11th most miserable country, out of the 98 countries in the index. Using today’s surging inflation rate of 75.8% in our calculation of misery, Iran would a rank 3rd, just behind Venezuela and Syria.

Without meaningful reform in Iran, more of the same will be expected for its economy and the rial. In the words of George W. Bush, “this sucker could go down.”

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When we commented earlier on the latest document leak involving Stormy Daniels’ lawyer and former Rahm Emanuel opposition researcher, Michael Avenatti, who “somehow” had gotten access to Michael Cohen’s wire transfer documents obtained by Richard Mueller as part of his investigation into Russian collusion, we asked just how it was possible that this critical piece of Mueller’s probe had been strategically leaked to the man who is now leading the legal charge against President Trump.

It appears we were not the only ones to ask that question because less than a day after Avenatti unveiled he had access to Cohen’s bank records…

After significant investigation, we have discovered that Mr. Trump’s atty Mr. Cohen received approximately $500,000 in the mos. after the election from a company controlled by a Russian Oligarc with close ties to Mr. Putin. These monies may have reimbursed the $130k payment.

— Michael Avenatti (@MichaelAvenatti) May 8, 2018

…  the WaPo reported that the Treasury Department’s inspector general has begun an investigation whether and how the confidential banking information for Essential Consultants LLC, the company controlled by President Trump’s personal attorney, was leaked.

Rich Delmar, counsel to the inspector general, said that in response to media reports the office is “inquiring into allegations” that Suspicious Activity Reports on Cohen’s banking transactions were “improperly disseminated.”

Bloomberg confirmed:

• TREASURY INQUIRY ON HOW BANK-SECRECY ACT DATA GOT TO THE PRESS
• U.S. TREASURY SAYS PROBING POSSIBLE LEAK OF COHEN BANK DETAILS

For those who missed yesterday’s main event, here is another recap from WaPo:

On Twitter, Avenatti circulated a dossier that purports to show that Cohen was hired last year by the U.S.-based affiliate of a Russian company owned by Viktor Vekselberg, a Russian business magnate who attended Trump’s inauguration and was recently subjected to sanctions by the U.S. government. The affiliate, New York investment firm Columbus Nova, confirmed the payment, saying it was for consulting on investments and other matters, but denied any involvement by Vekselberg.

Avenatti’s dossier also alleged that, after Trump’s inauguration, Cohen’s company Essential Consultants had received payments from several others with business considerations before the federal government, including telecommunications giant AT&T, aircraft manufacturer Korea Aerospace Industries and pharmaceutical company Novartis. All three companies subsequently confirmed the payments.

When he was reached by WaPo, Avenatti predictably refused to disclose his source:

“The source or sources of our information is our work product, and nobody’s business,” Avenatti said. “They can investigate all they want, but what they should be doing is releasing to the American public the three Suspicious Activity Reports filed on Michael Cohen’s account. Why are they hiding this information?”

Amusingly, Avenatti preempted this probe just last night, when he told CNN’s Anderson Cooper: “There’s been some criticism of our media strategy and how often I’m on CNN and how often I’ve been on your show and other networks. It’s working. It’s working in spades. Because we’re so out front on this, people send us information, people want to help our cause. People contact us with information.”

What was left unsaid is that it was not “people” who sent Avenatti the Cohen bank records, it was most likely someone deep inside Mueller’s probe who is leaking confidential information, making what was already a politicized probe, even more so.

And with the past 1.5 years of the Trump administration marked almost entirely by leaks, traditionally of the NSA/CIA/FBI to WaPo/NYT variety, it was long overdue that someone decided to finally took a look.

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Authored by John Mauldin via MauldinEconomics.com,

Central banks think the US and global economies are about to break from the post-recession doldrums. They believe their aggressive monetary policies – along with tax cuts and other factors – are finally bearing fruit.

As a result, the Fed is now tightening policy to prevent this inevitable growth sparking too much inflation. My friend Lakshman Achuthan of the Economic Cycles Research Institute (ECRI) is not convinced.

He recently sent some slides I want to share with you.

Economic Growth Is Slowing Down

The first one shows that the present, low-grade expansion phase is the slowest in a series. By the way, the ECRI is as close as we have to an “official” economic cycle watch service in the country.

Source: Economic Cycles Research Institute

This is growth during times when the economy is not in recession, which should be considerably higher than the full-cycle averages. It has been falling steadily since the 1970s and is now below 2%.

If the best we can do is 2% (not counting recessions), it’s hardly time to proclaim victory.

The next chart looks at the ECRI US Coincident Index, which is their alternative growth measure. The shaded areas are cyclical downturns, the three most recent of which did not reach recession status.

Source: Economic Cycles Research Institute

The important point here is we see little or no improvement in the growth rate. Since 2010, it has moved sideways in a tight range. In the last two years, it moved up to about the middle of the range, which is positive but doesn’t mean the US economy is off to the races.

GDP Growth Stalled in the Largest Economies

Finally, and most ominously, Lakshman shows this chart of quarterly GDP growth in the three largest developed market economies.

Source: Economic Cycles Research Institute

We see in all three places that quarterly growth peaked in mid-2017 and then fell in the last quarter. Yet the experts tell us a synchronized global recovery is forming. Really?

What I see here is a synchronized downturn. Granted, it’s just a couple of quarters but early data makes Q1 2018 look lower still.

If a recession is coming, GDP growth will decline from its present level to 0% or below. That process will likely unfold over a few quarters—and may already be beginning.

The Debt Gap Means Higher Interest Rates

On top of all this, we have a fast-growing federal debt. Yes, we owe this money to ourselves and maybe it will all balance out eventually. But we must get there first, and the road is not necessarily smooth.

Let’s look at some data from my friend Luke Gromen, who runs a unique advisory service called Forest for the Trees. The most recent letter from him had some fascinating points on the debt.

First, Luke says one of the least-noticed recent developments is that foreign central banks stopped net purchases of US government debt about five years ago.

Source: Forest for the Trees, LLC

This is important because someone has to fund our deficit spending and the job is not getting easier. It’s getting harder, in fact, as Luke’s next chart shows.

Source: Forest for the Trees, LLC

To this point, the Fed and Treasury have filled the gap with assorted contrivances such as forcing banks and money market funds to buy more Treasury bonds. These have run their course and no replacement tools are obvious.

That leaves one option: higher interest rates.

People will loan their money to the government if it gives them enough incentive. And higher yields will do it.

How much higher? We don’t know, but it won’t take much to further reduce bank lending activity, which will reduce M2 and push the economy closer to recession.

Investors will further extend their maturities, inverting the yield curve.

Watch Out

By now, everybody knows we are in the slowest recovery on record.

Lacy Hunt blames ever-increasing debt, which is a drag on growth. He has tons of academic literature to support his position, and I agree with him. That the next recovery will be even slower.

Go back to what Richard Duncan said earlier. When credit growth drops below 2%, a recession almost always follows. Lacy tells us that bank credit growth is down to 0.6% since the beginning of the year. That is ugly.

In short, there is not enough data to have me predict a recession and the consequent bear market. But there’s enough data bubbling up all around me that it makes me very nervous, and I am paying close attention.

You should be, too.

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