Iguacu Falls, which separate Brazil and Argentina, may be among the most dramatic wonders of the natural world. But the roar of 400,000 gallons of water crashing against rocks per second is a mere rumble compared to economic developments currently thundering on either side of the border.
Here, Pictet's Adriana Cristea and Guido Chamorro, both part of the emerging markets bond team, tell us about their recent visit to the two Latin American nations.
Six months ago, when I last visited, the country was code red: the economy was shrinking fast, inflation was rocketing and, with observers questioning whether the International Monetary Fund's (IMF) $50 billion in promised loans would come quickly enough, there was a growing risk that Argentina would struggle to refinance its debt.
Notwithstanding the market turmoil since, the worst seems over. In fact, during my latest trip a few weeks ago, I saw enough to be encouraged. True, the economy took a big hit last year, but it's now showing signs of life and refinancing risk has diminished. Argentina could prove to be the 'make or break' trade for emerging market investors in 2019. We think the country's bonds present attractive opportunities.
Spending time in Buenos Aires' most elegant districts, it'd be easy to miss the fact that Argentina's economy has been struggling. International flights to the capital are full, as is the Four Seasons hotel, and nice restaurants are booked solid through the week. The wealthy have clearly managed to insulate themselves from the crisis by converting their savings into dollars.
It is a different story for the rest of the population. After a strong start to 2018, the economy contracted over the year and inflation (at 55%*) has been rampant. But thanks to the biggest loan programme in the IMF's history, things are now looking better. Wages have started to catch up to prices and sentiment is stabilising. A good soy harvest could further boost growth.
The relationship between the IMF and Argentina seems quite strong, but it has to be. It'll be a long time before Argentina pays back its loans.
The market's big worry is what happens in October's presidential elections. For now, it's an open race between several candidates including Mauricio Macri, the country's market-friendly incumbent and Cristina Kirchner, the Peronist and anti-market former president.
The upshot is that Argentina's sovereign dollar-denominated bonds, although yielding 11% to 12%, are not particularly unique in emerging bond markets at the moment.
The market for local currency Argentinian bonds is much more attractive. They're the only bonds I can think of with yields approaching 50%. There's a reason for that: the Argentine peso's natural path is to depreciate with inflation at a pace of around 30% a year, leaving investors with real returns of around 20%. But the moves can be lumpy. The peso also has a history of sharp 10% falls every few months, with little obvious to trigger them.
So, however high the apparent yield, it's a place where it's easy to lose money if you get your timing even slightly wrong.
Complexo de Alemao is, in effect, a war zone. The favela, one of the most deprived in Rio de Janeiro, suffers extraordinary levels of violent crime in a country that already has a homicide rate at the WHO's threshold for conflict level violence. Yet even here there are reasons to be optimistic.
For example, Alan Duarte has created a safe haven in the favela where young people can stretch themselves through sport and essential skills in a facility that overflows with children's energy and enthusiasm. His is one of several EMpower-supported programmes I visited during my recent trip that are striving to transform Brazil from the bottom up. But for all the efforts of Alan and his like, the politicians are still going to have to do the heavy lifting. And while the signs are positive, hopes for Brazil have to be tempered with caution.
Brazil's new president, Jair Bolsonaro, took office at the start of this year looking to sweep away old-style politics, on the way to initiating a vast swathe of economic and social reforms.
His broom's got stuck.
A fragmented Congress, and strained relationships between it and the executive government, has left the government's crucial pension reform bill languishing. Bolsonaro's ambitions to cut pension spending by BRL1.2 trillion (USD302 billion) could well be pared back to around BRL500 billion by the time they get through (old-style) politicking.
That's a problem. We calculate Brazil needs a fiscal consolidation of around 2.5% of GDP - half was to come from pension reforms, the rest from privatisation and the removal of minimum wage indexation - in order to let the economy off the leash and restore investor confidence. I estimate the government will need to generate at least BRL800 billion (USD201 billion) in pension savings to create a bullish case for the economy.
Which helps explain why growth continues to disappoint and why, after initial enthusiasm, the mood among the Brazilian public is more downbeat, leaving Bolsonaro's poll ratings down sharply.
Consumption is muted, a consequence of a large amount of spare capacity in the labour market and slow growth in real incomes. The corporate sector, meanwhile, suffers from borrowing costs that, measured against US government bond yields, are five times higher than among Brazil's emerging market peers. A lack of competition, bureaucracy, poor adoption of technology, an ineffective judiciary, low recovery rates, all contribute to industry's problems that can't be resolved by official rate cuts.
Should Bolsonaro manage to push through pension reforms, the rest of his agenda could be plain sailing - most of it doesn't need Congress' approval. With that caveat in mind, the opening up of trade by reducing tariffs, boosting competition in various industries, privatisations, tax reform, labour reform should all be positive for the economy.
Indeed, government technocrats I met seemed energised, with a strong sense that they have a mandate to implement the sort of structural changes that will create a fairer, more open and productive Brazil. There is undoubtedly a way to go. Take education. Even though Brazil spends far more on each student than similar emerging economies, schools in disadvantaged communities are crowded and a lack of local security means children get, at best, 80 days in the classroom a year.
For now, foreign investors are right to be cautious. Flows suggest they aren't heavily invested in the country's bonds or currency. I feel that though the country's prospects look better than they did, and we might be past some of the worst of the political strains, much hangs on how the pension reform negotiations progress and just how far the proposed cuts are watered down.
We currently have a small overweight to the Brazilian real. Favourable developments in pension reforms would encourage us to build on this position and possibly move to an overweight in Brazilian local currency bonds.
*Source: Pictet Asset Management, 'Argentina – in the midst of the storm', May 2019
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the authors and do not constitute financial advice.