Bridgewater's Former Emerging-Market Head Bets on Biggest Losers

(Bloomberg) -- Argentina and Turkey were the poster children of this year’s emerging-market sell-off, but in 2019 they’ll be leading a widespread rally, according to Whitney Baker, the founder of New York-based Totem Macro, which advises funds holding more than $3 trillion in assets.

With U.S. economic growth slowing and dollar strength fading, riskier assets will return to favor, in particular those that got pummeled in 2018, the former head of emerging-market research at Bridgewater Associates said. That puts Argentina and Turkey, home to the world’s worst major currencies, at the top of the list.

“At this point, you make the most money in EM being long those countries that have just gone through this adjustment,” Baker said in an interview, recommending Argentine stocks and the Turkish currency.

The Canadian-born strategist said markets resemble the period around the turn of the century. That’s when balance-of-payment adjustments roiled Asia, then Russia and later Argentina, Turkey and Brazil, while the U.S. powered global growth. When the dotcom bubble burst in 2000, the S&P 500 Index and the dollar were trading at high premiums compared with the developing world. So as the Federal Reserve began easing, emerging-market equities took off. In the five years after touching a low in September 2001, MSCI’s developing-nation stock index returned 260 percent, quintuple the S&P’s gain.

“Relative growth went in their favor, easing U.S. financial conditions went in their favor, the dollar rolled over from overvalued values,” Baker said. “All of those things supported this massive relative outperformance of EM. I’d expect the same thing to play out.”

Here’s what else Baker had to say:

On what went wrong in Argentina and Turkey

• "Argentina and Turkey were really the last ducks in a row."
• "In Argentina, you had this idea of a reformist leader coming into the market and issuing and ultimately it was just the same thing they’ve done every other time which is they use that access and that bullish story to issue a lot of debt to ease fiscally, transferring purchasing power to the private sector which uses it to buy imports. So you see the fiscal and current-account deficits expand at the same time and that leads to debt sustainability challenges and short-term funding risks."
• "Turkey responded to the coup by juicing the economy in a huge way. That pushed their current-account deficit back. This was huge. Then the currency had started to fall precipitously and they weren’t responding. Under the new central bank governor and finance minister, there was generally a lack of credibility. The central bank governor wasn’t permitted to hike in any way even as inflation was spiraling higher."

On why they’re now her top trades

• "We became bullish on Argentina around August after they secured the first IMF deal."
• "We did a case study of all the IMF deals. People focus on short-term news flow like whether Mauricio Macri gets reelected. The reality is in all 12 case studies we looked at there’s always political volatility and the economy is contracting."
• "The way you break even is if the currency falls 15 percent in real terms but that seemed like a low probability. There was an extreme buffer."
• "In early September, Turkey finally hiked again by a more significant amount. We covered our short in the spreads and went long local assets."
• "In Argentina, the best risk-reward play has moved from the local currency to the equities to play for that growth upside as the deleveraging pressures ease. Multiples there are still dirt cheap. On the Turkish side, I’m more comfortable staying long the currency."

On her two biggest worries

• "There are two countries I worry about. China, I don’t know what will happen there. I think they’re doing the right thing prioritizing an injection of liquidity. If they tighten it or if they just lose control of the credit dynamics which are on a hairpin, then you had a huge buildup in debt and this set of domestic bubbles which you could see considerable contagion from both onshore and, if there’s a large depreciation in the renminbi, you’d expect the Korean won to suffer and a commodity consequence. That’s one elephant in the room. China is the latest cycle of all these countries and has an unsustainable debt situation."
• "The second one is Brazil. A reform narrative can go a long way towards disguising a fundamentally unsustainable situation. In Argentina, it was clear last December they had a ton of dollar debt and no dollar assets to pay it. The only thing keeping spreads at 200 or 300 basis points over Treasuries was this idea that reforms would unleash a growth boom that allowed them to grow out of their debt problems. The same thing is happening with Jair Bolsonaro. What the market is missing is Brazil has so much institutional rigidity. It’s not even up to him."

To contact the reporter on this story: Ben Bartenstein in New York at bbartenstei3@bloomberg.net

To contact the editors responsible for this story: Rita Nazareth at rnazareth@bloomberg.net, ;Jeremy Herron at jherron8@bloomberg.net, Brendan Walsh

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