Argentina’s Rally May be Short-Lived

Quiet as it has been kept, the embattled Global X Funds (NYSEARCA:ARGT) jumped over 10 percent in the past month prior to the start of trading Tuesday.

The catalyst has been a strong rally in Argentine sovereign debt, which was under heavy pressure late last year as speculation swirled the South American country could be headed for its second defaullt this century.

Argentina's Rally May be Short-LivedThe catalyst for the rise in Argentine bonds is, as Barron’s notes, speculation that a recent decision by a U.S. judge that Argentina must pay bondholders $1.5 billion will be hard to enforce.

The Bank of America Merrill Lynch Emerging Markets Sovereigns Argentina USD Index has surged 29 percent since November 29, according to Barron’s. Said another way, since November 29, Argentine sovereign debt has been nearly three times the investment that Global X Funds (NYSEARCA:ARGT) has been.

Another reason ARGT may be getting a lift is valuation. As in Argentine equities as measured by the MSCI Argentina Index, not the index tracked by Global X Funds (NYSEARCA:ARGT), trade at just four times forward earnings. That means Argentina’s equity market is far less expensive than rivals in Brazil, Chile, Colombia and Peru.

However, value in Argentina could be more a case of value trap than anything else. Barron’s cites a Citigroup research note that says the chances of the U.S. ruling in favor of the bondholders is unlikely to be overturned and “the chances of a technical default still remain high.”

Argentina equity bulls, presumably a group small in population, could point to the fact that Global X Funds (NYSEARCA:ARGT) is in rally mode and that the ETF devotes 36.5 percent of its weight to consumer staples stocks. That would imply a certain degree of insulation from macro events. While there is no refuting ARGT’s recent bullishness and a presumably favor sector weight, there is also no refuting the fact that Argentina is nowhere close to out of the default woods.

As has been previously mentioned, another sovereign default could easily be the last straw that leads index providers to revoke Argentina’s frontier market status.

Msci Inc (NYSE:MSCI) has already cautioned that is a real possibility as has FTSE Group, the provider of ARGT’s underlying index. What type of purgatory awaits countries that are demoted from frontier market status remains to be seen, but it is also clear that those types of headlines have weighed on Global X Funds (NYSEARCA:ARGT) in the past. Translation: ARGT could be 100 percent allocated to consumer staples and still be vulnerable to downside caused by rising bond yields as well as the loss of the frontier market status.

With headline risk high and an anti-free market government still in place, Argentina’s economy and equity markets represent high-risk bets. Those looking to participate in potential upside without the commitment of an “all in” Argentina bet should consider the iShares MSCI Frontier 100 Index Fund (NYSEARCA:FM). FM features a modest allocation of about three percent to the South American nation.

This article was originally written by The ETF Professor, and posted on Benzinga.

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