Investors applaud Political Changes in Brazil & Argentina: Which Leaders are next?

by Ken Brown

Changes in governments matter more today because there are few attractive investment options.

In a world of richly valued markets and paltry yields, one way to make money is to bet on political drama.

The market cheered the impeachment and likely departure of Brazil’s Dilma Rousseff even before Sunday’s vote. The next day, investors were shoving each other aside to grab a piece of Argentina’s first bond offering since its new government took power.

Despite deep economic troubles in both countries, investors are betting optimism over new leaders and changing policies will drive up stock and bond markets.

“Investors are looking for that rare story that has a catalyst on it,” said Samy B. Muaddi, an emerging-markets-debt portfolio manager at T. Rowe Price.

This bet has long been an obvious if not always profitable trade in emerging markets. The last wave of change was in 2014, when Narendra Modi took power in India and Joko Widodo became president of Indonesia. Shares rose roughly 20% in India and Indonesia in the months leading to the election and held up later that year even as other emerging markets tumbled.

Changes in governments matter more today for two reasons: There are few attractive investment options, and many markets are moving in sync, driven by factors like commodity prices and U.S. interest rates.

A rally this year has pushed up emerging markets 7.3% through Tuesday, compared with a 2.8% rise in the S&P 500. That has forced investors to take on more risk to stay in the game, which means looking for turnaround stories, even if the turnarounds are largely uncertain.

The fun part is picking the next to fall. Topping the list are South Africa’s Jacob Zuma and Malaysia’s Najib Razak. Both leaders face corruption allegations and are under pressure to resign, though both are political survivors with strong party backing.

What excites investors is that both countries have young populations that are brimming with potential. What worries them is that both countries depend on China buying their commodities and both face policy paralysis caused by unpopular leaders and entrenched party establishments.

As with all emerging markets, both countries are unloved by investors and cheap on many measures. There are plenty of ways to make a buck in both places—appreciating currencies, better corporate earnings and improved investor sentiment.

The risk with betting on change in emerging markets is that problems are so deep and the global economic situation so weak that the optimism can dissipate quickly. And there is the possibility that the bad government can still get worse.

In South Africa, Mr. Zuma backed off a plan to replace a respected finance minister after markets sold off. In Malaysia, Mr. Najib appointed a political ally who served on the advisory board of a scandal-plagued government investment fund to replace the country’s widely respected central-bank head who is retiring.

Then there is undoing the mess left behind by the previous government. For many emerging markets, that means somehow paying off big piles of debt that were typically squandered on bad policies or used for political favors. Brazil’s debt tripled to $1 trillion in the last nine years and all three major credit-rating firms reduced the country’s rating to junk. The economy shrank 3.8% last year and will likely shrink again this year, making the debt even more burdensome.

But investors think back to 1992 and the last impeachment in Brazil, when then President Fernando Collor was charged with corruption. His resignation eventually ushered in the presidency of Fernando Enrique Cardoso, who oversaw the country’s economic revival.

As heartless as they can be, investors appear to be very forgiving these days. Witness Argentina, which has been at war with hedge funds for 15 years and whose central bank said earlier this year it would start printing higher-denomination bank notes to deal with inflation that is estimated at around 40%.

The buying frenzy for Argentina’s offering—$70 billion in orders for $16.5 billion in bonds—should be incentive enough for every country with a lousy government to make a change. It is staggering that investors would lend money for 30 years to a country that just emerged from a default in return for a yield of just 8%. Buyers apparently bid up the bond prices further after the deal.

But with emerging-market currencies up about 10% from their lows and bond yields down to 4.6%, there aren’t many options to get a juicy return.

There’s the frenzy and then the hangover. Two years after Messrs. Widodo and Modi took over Indonesia and India, respectively, investors have started to lose patience with the pace of change, even though both countries are doing reasonably well.

The game of who is next to fall is tough. Messrs. Najib and Zuma could hold on until the end of their terms in 2018 and 2019, respectively. The next big fish on the investor wish list: Vladimir Putin. One can always dream.

Fuente: THE WALL STREET JOURNAL

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