Argentina’s Massive Sell-Off Had a 0.006% Chance of Happening

(Bloomberg) -- There was a 99.994% probability that an event like Monday’s sell-off in Argentina wouldn’t happen.

But it did. And it served to underscore the need for investors to protect against extreme events that look very unlikely but can have outsize impact if they do occur.

The flip side of this logic is that when things look decidedly bad, betting on average outcomes and mediocre returns could be futile. Some traders prefer what they call the barbell strategy -- simultaneously allocating funds for the two extreme and opposite possibilities: a deeper slump and a sharp rebound.

That means the bravest investors looking at the meltdown in Argentina won’t take the middle road. Rather, they will reshuffle their portfolios to outperform both in a slump and a rebound.

Here’s where extreme buying opportunities lie:

Outlier Event

The rout in Argentina’s dollar bond due January 2028, which drove up the yield by 525 basis points, was a 4-sigma event, according to Bollinger Bands. That means the move was four standard deviations away from its 20-day moving average, an event that’s expected to happen only once in several decades.

In practice, however, these events could be more common than what statistical models like the normal or laplace distributions suggest.

While recent events disproportionately affect traders’ sentiment, some investors look beyond the extreme move and bet on a quick return to more normal levels. The Black Monday rout in Dow Jones Industrial Average on Oct. 19, 1987, was followed by gains of 11% in three months, 15% in six months and 23% in a year.

So, some bold investors may wager the same will happen with Argentine bonds.

Carry traders will be looking for some sign of stability in the peso after the currency’s 15% slide on Monday. If or when calm returns, the arbitrage potential may prove irresistible. The sell-off made the currency so cheap that its implied carry relative to the dollar has surged to the highest level since Argentina moved to a free-floating currency regime in December 2015.

Argentina has become the cheapest emerging market after Monday’s rout.

At the same time, analysts’ 12-month estimates for profit at companies in the S&P Merval Index rose to an 11-month high, in peso terms. But the tumbling currency meant dollar-based forecasts plummeted the most in a year. That’s a barrier for global investors for now, but a so-called dead-cat bounce in the peso may revive the dollar-earnings figures, making stocks look even cheaper.

To contact the reporter on this story: Srinivasan Sivabalan in London at ssivabalan@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Justin Carrigan

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