GCLetterV2,#2,Thursday18,May2017

TheBayesianStaker
BacktothePreviousFuture

Inourpreviousletter,wenotedthatgrowthoptimismseemedtohaveremaineddespitepolicy
implementationdelaysintheUS,butarguedthatPresidentTrumpspolicyagendawasfarfromsecure,
warningaboutthepossibilityoffurtherdisappointment.Atthesametime,wehighlightedthattheUS
economy continued to recover, the orderly US rate selloff looked losing steam, and asset market
volatility remained subdued given the potential shocks ahead, particularly in FX, equity, and credit
markets. We acknowledged that such relatively serene market conditions were really remarkable,
particularlygiventhedegreeofpolicyuncertaintyintheUSandofpoliticalambiguityinEurope,ahead
of yet critical elections in Netherlands, France, Germany, and Italy. Yes, as discussed, excess global
savings endured, and the changing paradigm in the US was encountering too much uncertainty to
robustlytestthatdeflationaryglobalsetting.Butwefearedthataftermanyyearswithoutinflationary
threats, this low rate/low volatility background could rapidly change under different combinations of
Trumpspolicypromises.

The US administrations difficulties to introduce minimum modifications to the socalled

Obamacare health bill simply confirmed President Trumps challenges to move its policy agenda
forward. Indeed, the Obamacare fiasco further exposed the intrinsic contradiction facing the Trump
administrationdiscussedpreviously,wherethePresidentsboldnesscouldbeitsmaindrivebutatthe
sametimeitsworstenemy.Asnoted,Mr.Trumpseagernesstopushforwarditsinitiativesundervalues
importanttradeoffs,constantlytaxingitsconservativeconstituency.Suchaninternalconflictwouldbe
even more evident in the coming discussion on the corporate tax reform. Fiscally weakened by the
Obamacareresilience,andwithoutenoughpoliticalsupporttoincreasethefiscaldeficit,anaggressive
taxreformwouldbeonlypossiblewithsomerevenuemeasure,suchasthebordertax.However,the
bordertaxcouldbequitedisruptivegiventhelikelytransferofwealthamongwinnersandlosers,and
politicallyunappealing.Therefore,amassivefiscalstimulusislookingnowincreasinglyunlikely.

Intheinterim,theDutchgeneralelectionandtheFrenchpresidentialvotebroughtsomesense
ofpoliticalstabilityinEuroland.ThenextfocalpointistheSeptember24thgeneralelectioninGermany,
butchancellorMerkellookslikelytoextendherleadershipforanother4years,andbeabletousesome
fiscal power to maintain growth momentum. Meanwhile, the EU economy has sustained a solid
recoverypathandtheECBiscurrentlydiscussingthebesttimingtoslowlyreduceitsquantitativeeasing
stance. Similarly, the Chinese economy has shown new signs of marginal growth deceleration, but
continuing to transit a delicate deleveraging process with relative success. Probably much more
importantthananyotherfactoraffectingtheglobalfinancialpicture,theUSlaborsupplyhasrecently
suggestedsignsofafadingrecoveryinparticipation,squeezingthismarketfurther,andconvincingthe
Fedoftheneedtostarttighteningmonetaryconditions,firstbypushingFedFundsrateup,andundoing
balancesheetinvestmentslater.

Thus, it looks like the global financial outlook is now very much resembling the expected
landscape prevailing before President Trumps surprising victory in November last year, albeit with a
slightlystrongerworldeconomy.Thisseemscharacterizedbyacoupleofconfrontingforces,likeexcess
global savings and depressed growth sustaining low interest rates, and stretching labor market
conditions, particularly in the US, demanding monetary tightening sooner rather than later. At the
currentjunction,valuationofmostfinancialassetslooksfragileatbest,buttheredoesnotseemtobea
consensusview.Indeed,therearesellsideresearchrecommendationsforalltastes.Thereareanalysts
still hoping to see the positive impact of deregulation and some fiscal impulse, endorsing long equity

and credit positions, but short bonds; while there are others afraid of growing disappointment with
economicrealityovertime,andmuchmoreworriedaboutanequitycorrection.Andinthemiddle,we
havetheFed,theECB,andtheprospectofraisingratesbutstillchallengedbytheglobalsavingsglut,
thesubduedinvestmentprocess,andpoorproductivitygeneration.

AgnosticabouttheTrumpsadministrationabilitytopushforastrongreflationaryprocess,we
sit on the side of those dreading the US equity market more than anything else. In our view, the US
economy is recovering but capped by a slow potential growth pace. Although we do not fully yet
disregard the possibility of Trumps positive policy surprises, we feel the risk/reward metric is
particularly worrisome for US equities, as valuations remain high mostly sustained by expectations of
strong returns to come, very low volatility, and a relatively weak USD. The latter could be a fragile
supportiftheFedconfirmsitspathofhigherratestooffsetinflationarypressureswithoutameaningful
changeinthemediumtermgrowth&investmentoutlook.Atcurrentlevelsofvaluation,realratesand
the USD/EUR, credit markets might also be vulnerable. In this regards, EM bonds might still offer a
sensible proposition despite high valuation as well, particularly in a world of gradual monetary
tightening in the US, but without major candidates for market disruption besides the equity market.
Nevertheless,insuchanenvironment,wedofavorthesearchforsomehedges,beingequityvolatilityor
USHYspreadthemostlikelytobeeffective.

Notwithstanding the consideration above, we still feel rather comfortable holding Argentine
1
risk,asdiscussedinourrecentpublication,Argentina:AFragile,YetPromisingPreElectoralPath .After
twomonthsofstrongsocialtensionandgrowingpoliticalthreattothegovernment'seconomicagenda,
PresidentMacrisadministrationseemstohaveregainedpoliticalinitiative.Thisrepositioning,however,
ishardlytheresultofthegovernment'sachievements,butactuallythereflectionofadividedpolitical
oppositionstillrepresentingtheworstofthepast,atleastamongthemoreindependentsectors.Infact,
economic recovery is still slow and heterogeneous, likely to sustain political fragility until midterm
elections. But the government holds some leverage in this rocky road towards the October elections,
particularlyfavoredbytheexpectedeconomicimprovementanddispleasingoppositionalternatives.In
our view, this and relative valuation, vis a vis other emerging markets, should sustain interest in
Argentinasassets.

In summary, while doubts on the US and the global scenario persist, holding a core mid
duration USD EM debt, with an important Argentine bias, seems to remain a good investment
proposition. InArgentina,we favor a barbell strategy inthe sovereign curve(long LETES, DISCOS, and
PARS)combinedwithmiddurationsubsovereignandcorporatebondsintheUSDfront,andLEBACSin
ARS.Somepesoassetswithactivehedgingstillseemlikeamusthave,asthemacroeconomicforcesin
Argentinacontinuetopushforfurtherrealappreciationofthecurrency,absentexternalshocks,even
after the Central Bank has acknowledged some concern about a very strong peso. Furthermore, we
might add some Argentine and Brazilian equities to that portfolio, but only strategically, as we fear
globalequityvaluation.However,aftertodaynewsinBrazil,wewouldberathercautiousonBrazilian
assetsforthetimebeing,expectingimportantdelaysinthereformfront.Finallywewouldincludesome
globalequity,credit,andFXvolatilityprotectionasadefensivetacticamidhighglobaluncertaintyand
theviewthatglobalratesandassetpricevolatilityhavemorespacetorisethanotherwise.

AgnosticaboutReflation;ConcernedaboutLaborDynamics
Asdiscussed,theabilityofanewUSadministrationtoimposearelativeaggressivefiscaland
deregulatory agenda threatened to feature a game changer event, potentially able to move the US
economyawayfromitsprotractedanemicgrowth,atleasttemporarily.PresidentelectDonaldTrump
has also promised to curb free trade and free labor mobility, which could eventually represent a
handicapforeconomicgrowth,neverthelessexacerbatingthecombinedimpactoninflationintheshort
run.However,afteraninitialspikeofoptimism,therehavebeenincreasingdoubtsregardingthenew
administrationstalenttodelivereffectivelyonitspromises,bothongrowthandprotectionism.Thus,

1
Argentina:SBSMonthlyReport,April27,2017.

weseemtobebacktothefutureprojectedbeforetheNovemberPresidentialelection,wheremonetary
policyisbackoncenterstage.

The first but failed attempt to undo part of the Obamacare legislation back in March
representedanearlyrevelationofthedifficultiesaheadforPresidentTrumpseconomicagenda.Finally,
the government was able to get some Obamacare reform hardly passed in the Lower House but
discussions at the Senate suggest further gridlock on the official initiative. Even more difficulties are
likelytoariseforthePresidentstaxproposal.

TheWhiteHousesopeningstatementofidealsconcerningthetaxreformhasnotyetprovided
enoughcontentdetailstoanticipateabroadbipartisanagreement.Althoughpersonaltaxbreaksappear
tofavorthemiddleclasstosomeextent,theybenefitthewealthyaswell,openingthedoorforstrong
criticismfromtheDemocraticbase.Infrastructureandchildcareplansmightalsobepopular,butdetails
aremissing.Likewise,theomissionofaconcretebordertaxadjustmentshowsnotonlythePresidents
lackofendorsementontheHouseRepublicansproposalbutlimitedbipartisansupport.Nevertheless,
TreasurySecretaryMnunchinhascontinuedtosuggestsometerritorialalternativesthatcouldintroduce
anotherblockingstonefurtherdowntheroad.Withoutasourceofsignificantrevenuegeneration,the
aggressivecorporatetaxreductionenvisagedremainsatoddswiththeSenatesreconciliationrulesthat
limit any widening in the fiscal deficit. A higher deficit would also be directly against the preference
revealedbythemoreconservativelegofCongress,suchastheKeyFreedomCaucus.Therefore,atimely
tax cut driven fiscal stimulus is still possible but not more likely than before, and certainly not more
probablethanthestimulusimpliedbytheremainingoptimisminexpectations.

Forexample,afinalreductionincorporatetaxratefrom35%to25%(halfoftheenvisagedin
theWhiteHousestatement)togetherwithamodestcutinindividualincometaxesisestimatedtoboost
2
USGDPbylessthanhalfapointbasedonsimulationswiththeFedsFRB/USmodel. Thelatterseems
consistentwiththeCBOcurrentbaselineandBloombergmedianforecastanticipatingafederalbudget
deficitwideningbyonetenthofapercentofGDPthisyearandthreetenthsnextyear.Thus,itappears
today that, on average, expectations do include a decent fiscal impulse, although economic forecasts
stillreflectawiderangeofprospects.Indeed,Figure1belowreportsimplieduncertaintyfromeconomic
forecasts for the US economy from a sample of 62 forecast institutions surveyed by Bloomberg L.P.,
were20172018growthprojectionsrangefromaminimumof1.2%toamaximumof4.5%,consumer
priceinflationfrom1.2%to4.0%,theEUR/USDexchangeratefrom0.97to1.25,and10Ytreasuryrate
oscillateswithin200bps!

Figure1:Divergentbutpersistentgrowthoptimism

GDP(%) CPI(%) EUR/USD UST10Y(%) FiscalDeficit(%GDP)

2017 2018 2017 2018 2017 2018 2017 2017 2018
MedianBloomberg 2.20 2.30 2.40 2.30 1.10 1.14 2.80 3.20 3.50
Min 1.20 1.50 1.50 1.20 0.97 1.00 1.60 2.70 2.40
Max 2.70 4.50 3.70 4.00 1.20 1.25 3.65 5.00 5.80

BankofAmerica 2.10 2.50 2.10 1.80 1.08 1.15 2.85 3.10 4.00
Citibank 2.10 2.60 2.40 2.30 1.05 1.05 2.65 3.00 3.80
DeutscheBank 2.30 2.60 1.90 2.20 1.02 0.95 2.90 3.20 3.50
JPMorgan 2.00 1.80 2.20 2.20 1.15 1.15 3.00 3.30 3.60
MorganStanley 2.00 2.00 2.50 2.10 0.97 1.05 2.50 4.30 5.80
Source:BloombergLP.

Opportunely,recentdevelopmentsinEuropehavebeenmorestabilizingthanpoliticaleventsin
theUS.TheofficialvictoryintheNetherlandsgeneralelection,orthemassiverejectionforsegregation
and antiEuropean initiatives revealed in Frances presidential election, have brought some relief to
economicrecoveryinEuropeandEURsupport.ThistrendislikelytobereinforcedbytheSeptember
24th general election in Germany, where chancellor Merkel is expected to extend her leadership for

2
AvailableontheFedweb:www.federalreserve.gov/econres/usmodelspackage.htm

another4years,andbeabletousesomefiscalpowertomaintaingrowthmomentum.3Likewise,itis
also valid to argue that despite remaining hazards in the delicate Chinese deleveraging process, the
Asian economic path has remained fairly smooth, although risks still remain. Thus, global growth
indicatorspointtosustainedpositivemotionintothisquarter,stayingwellabove3%,andshowingsome
demandrotationawayfrom China.Thelatterbeingfeltbythe commodityspectrum, butmollifiedby
forwardoilmarketsstayingataround50USD/bbl,undertheviewthatconstantcontrolbyoilproducers
wouldpreventanewfallinprices.Inreality,oilinventorieshaveremainedhighbyhistoricalstandards,
but global growth is being sustained and producers have remained fully committed to maintain
coordination.

Inthemeantime,theUSFedseemsincreasinglypoisedtoraiseratestwomoretimesthisyear,
inJuneandSeptember,andhasrecentlyreinforceditsdesiretostartphasingoutthereinvestmentofits
balance sheet in December. The latter seems consistent with the view that 1Q17 weakness has been
transitoryandmostlyweatherrelated.Indeed,withemploymentrisinganaverageof174,000overthe
pastthreemonths,theUSeconomyseemstobealreadyoperatingatfullemployment.Currently,the
unemploymentrateis4.4%,declining0.4%inthelastfewmonths.Simultaneously,productivitygrowth
continuestofrustrate,declininglastquarterandpushingannualgrowthtoonly1%overthepastyear,
further adding to weakening supply side sources to counteract labor demand price push. The latest
laborreportinformingariseinunitlaborcostgrowthto2.8%YoYisaclearindicatorthatwageinflation
ispressuringcorporateprofitmarginswhileproductivityfailstopickup,aspicturedinFigure2below.

Figure2:RaisingunitlaborcostamidslugishproductivityintheUS

160 ManufacturingLaborCost
150 NonFarmingLaborCost
ManufacturingProductivity
140 NonFarmingProductivity

130

120

110

100
1Q2012=100
90
03/2012 11/2012 07/2013 03/2014 11/2014 07/2015 03/2016 11/2016

Source:BLSandBloombergL.P.

Falling energy prices in recent weeks have helped maintained inflation at 2.2% YoY (1.2%
annualizedinthethreemonthsthroughApril!).Surprising,coreinflationfellaswell,nowbelow2%YoY,
althoughpartlyaffectedbyalargedeclineinglobalfoodpricesdrivenbytheChinesemarket.However,
thisrecentpricebehaviorshouldbeunderstoodasreflectinghighvolatilitymorethanatrend,where
recovery in global growth and tightening US labor market conditions should be in command in the
medium term, particularly as last years rise in labor force participation rates looks like slowing or
pausing. The latter should not be much of a surprise, as demographic trends continue to push
participation rates lower. Furthermore, recent studies on the labor market have suggested that most
recentincreasesinlaborforceparticipationhadbeenmoretheresultofaslowerrateofdeparturefrom
thelaborforceofthelongtermunemployedthanthecyclicalreflowofdiscouragedworkersbacktothe
laborforce.4Thus,wemightwellbewitnessinganearendingoftheriseinlaborparticipationandthe
goingbacktothestandardlabormarketstretchingsoonerratherthanlater.

3
MorelikelythaneverafterthesolidvictoryobtainedthispastweekendinNorthRhineWestphalia.

4
See for example the analysis presented by Alan Krueger in the last Falls Boston Fed conference, in
October2016,entitledWhereHaveAlltheWorkersGone

Figure3:ActualUSlaborforceparticipationrateandprojections

Source:AlanKruegersWhereHaveAlltheWorkersGone,Oct,2016

Absentanexogenousstimulus,suchachangingdynamicinthelabormarket,togetherwitha
still subdued business spending on capital goods and productivity generation, brings back worries of
short term inflationary pressures without a constructive modification of the long term perspective.
Therefore,whiletheexcitementregardingasolidliftininvestmentdemandisfading,inflationpickupis
becomingincreasinglytheshorttermrisktotheUSeconomicoutlook.Inotherwords,thefundamental
sources sustaining the global savings glut appear to have remained, as well as the prospect for
protractedlowrealinterestrates,butnominalshocksseemtoberegainingpredominanceintheshort
term.

Figure4:UScapitalspendinghasyettoconfirmanupwardlift

14% 25% 10% 50,0

12% 20%
40,0
15% 5%
10%
30,0
8% 10%
0%
5% 20,0
6%
0% 5% 10,0
4%
5%
2% 0,0
10% 10%
0% 15% 10,0
2% 15%
20% 20,0
4% 25% 20% 30,0
06/2011 12/2012 06/2014 12/2015 06/2001 09/2004 12/2007 03/2011 06/2014
RealPrivateBusinessInvestmentQoQAnnualized
RealPrivateNonresidentialFixedInvestmentQoQ
CapitalGoodsOrdersQoQAnnualized(rhs) NYFedFutureCapitalExpendituresIndex(rhs)

Source:BEA,FRB,andBloombergL.P.

DisappointmentFears,EquityValuation,andLowVolatilityBackdrop

Despite1Q17demandweakness,thedominantexpectationremainsarecoveringUSeconomy.
Consensus estimates point to growth exceeding 2.0% this year while the Fed's GDP trackers already
suggest a faster pace of growth. Likewise, survey data has been rather strong, but exacerbated by
measuresofconsumerandbusinesssentiment,whichareforwardlookingorsimplyexpectations.Such
abenignviewaboutthenextfewmonths,nonetheless,coincideswithdiminishingexpectationsabout
Trumps coming fiscal impulse as discussed above. Thus, if any, there seems to be more room for
disappointmentthanpositivesurprises.

 In such an uncertain policy and economic environment, risk assets have performed relatively
well.Equitieshavebeenupagaininmorethanamonthwhilebondyieldshavebeenrisingsmoothly,
somehowreflectingapositivegrowthandinflationtrend.Thisnotwithstanding,thereseemstoremain
an increasing vulnerability in asset pricing, particularly for those depending critically on economic
growth.First,asdiscussed,currentexpectationsarestillbasedonsomedegreeofoptimismregarding
PresidentTrumpsprogrowthpolicyagenda.Figure5belowsomehowpicturesthedisparitybetween
expectations and leading indicators in US vs EU. Second, business fixed investment has remained
sluggishalthoughordersofcapitalgoodshavebeengrowingrecently.Thus,cheerfulnessisyetbasedon
Feds surveys on plans to increase capex in the near future, and recent improvement in the energy
sectorrespondingtopartialrecoveryinoilpricesoverthepastyear.Regulatoryeasingisalsoexpected
tokeepliftingbusinesssentiment.However,capitalspendinghasbeenjustapromiseforalongwhile,
yet unable to produce the significant increase in productivity needed to envision a faster pace of
sustainablegrowth.Third,growthincapitalserviceshasreboundedbutremainslow,comparedtothe
precrisis levels, adding doubts on a rapid pick up in labor productivity growth. Fourth, the low
productivity,lowlaborparticipation,risinglaborcostpathisincreasinglydemandingtightermonetary
conditions in the immediate future, independently of the final performance of investment and
productivitygrowth.

Figure5:US/EUeconomicactivityindataandexpectations

125 USLeadingIndex 220 106 220

EULeadingIndex
USGDP EUGDP
200 105 200
120 USPMI(rhs) EUPMI(rhs)
104 180
180
115
103 160
160
102 140
110
140
101 120
105
120 100 100

100 100 99 80
05/2014 02/2015 11/2015 08/2016 05/2014 01/2015 09/2015 05/2016 01/2017

Source:BloombergL.P.

Therefore,tightermonetaryconditionsrespondingtoinflationarypressureswithoutclearsigns
of a faster sustainable pace of growth in the US does not exactly bode well for risk assets. Similarly,
inflation worries should be a major risk factor for bonds, but might be contained by excess savings
globally and depressed economic perspectives in the medium term. In addition, USD strength due to
higherratedifferentialsinfavoroftheUSwillfurthercapcorporateearningsifafasterpaceofgrowthis
not the underlying source of greater demand and inflation. Interestingly, higher US rates have been
accompanied by a weaker USD in recent weeks, mostly for political reasons (France elections vs.
Trumps campaign dealing with Russia, among other factors), soothing the net effect on equity
valuation. Figure 6 below shows the S&P index adjusted by inflation, compared with the USD real
effectiveexchangerate,andrealratesimpliedin10YTIPS,illustratingthatrecentstrongperformancein
the equity spectrum has been contemporaneous with higher real rates but a depreciating USD. This
notwithstanding,bothrealratesandtheUSDREERarelikelytorisefurther,possiblychallengingequity
valuation,unlessaccompaniedbyasolideconomicrebound.

Figure6:USequity,itsdriversandvolatility

180 S&P500inflationadjusted S&PSharpe

4,0 50%
USREER
170 S&PVolatility(rhs)
10YTIPSrate(rhs) 1,0% 45%
3,0
160 40%
150 2,0 35%
0,5%
140 30%
1,0
130 25%
0,0% 0,0
120 20%
110 1,0 15%
100 0,5% 10%
2,0
90 5%
80 1,0% 3,0 0%
01/2012 01/2014 01/2016 1996 1999 2002 2005 2008 2011 2014 2017

Source:BloombergL.P.

USequityoptimistsarguethathistoricallylowvolatilityindicatorsshouldalsoanticipatesteady
returns. We have a hard time agreeing with that proposition, particularly in a policy environment as
uncertainastheonedescribedpreviously.Inaddition,wenotedthatconsensusforecastsandmarket
expectations have continued to have a positive Trump premium, although fading gradually overtime.
The latter also presents a biased risk/reward condition, where frustration seems to be less expected
than otherwise. Therefore, for the reasons above, we would be quite cautious regarding equity
investment, at least not until having more concrete evidence that some meaningful fiscal stimulus is
likely,and/orfixedinvestmentdemandisfinallypickinguponasustainedbasis.

Asimilarconsiderationguidesourfixedincomeselection,whereUSHYcorporatecreditshares
someoftheriskfactorsfacingUSequities.Thelatterexacerbatedbyhistoricallylowvolatilityindicators
inmostassetclasses,butparticularlylowinUShighyield.Again,inasteadilyimprovingenvironment,
declining volatility inasset prices shouldbe a welcomingand reassuringconfidence factor.The latter,
however,couldwellbackfireifsuchimprovementprovestobejusttemporary.

AppetiteforUSHighYieldCorporatesandEmergingMarketsseemsevenstrongerthanpreUS
election days, with the US High Yield 10Y spreads tightening by more than 100bps, almost twice the
compressionwitnessedinEM10Yspreadsinthesametimespan.Inthemeantime,10Ytreasuryrates
areabout60bpshigherthanbeforetheelectionbutalmost30bpslowerthantheirpeakinMarchthis
year,andcertainlystillwellbelowtheirposttapertantrumpickof300bps.Thus,bothHYandEMare
vulnerabletorisinginterestratesdrivenbyinflationqualms,butHYmightbemoresogivendirectlinks
with US growth disappointment, recent performance, historically low volatility, and weaker credit
qualitythanEM.

Figure7:HY/EMRelativevaluationandvulnerability
3,0 4,0

HY5YRSPRD/EM5YRSPRD 3,5
2,5
HY5YRSPRD/EM5YRSPRDAdjustedby90dvolatility(rhs) 3,0
2,0
2,5
1,5 2,0
1,5
1,0
1,0
0,5
0,5
0,0 0,0
10/2012 05/2013 12/2013 07/2014 02/2015 09/2015 04/2016 11/2016
Source:BloombergL.P.

 Interestingly,thepartialrecoveryin10YratessinceApril18,roughlybyabitlessthan20bps,
has been accompanied by a relatively stable breakeven inflation, at around 1.85%, although showing
some recent volatility. Thus, increasing nominal rates in recent weeks has been reflected by a similar
increase in real rates, and some added risk premium, as pictured in Figure 8 below. Based on the
discussionabove,bothratefactorshaveroomtomovehigher,butstablebreakeveninflationrecently
mightbeanadditionalsourceofconcern.Nevertheless,asdiscussed,riskpremiummightbestillvery
sensitivetoprevailingpolicyuncertaintyanditsrelativelylowlevelfromhistoricalstandards.

Figure8:Riskpremiumslightlyup;inflationexpectationsnotmuch

AdrianCrump&Moench10YTreasuryTerm TermPremium Breakeven

4,0 Premium 0,5
0,4 2,4
3,5 USBreakeven10Y
0,3
3,0 0,2 2,2
0,1
2,5 0,0 2,0
2,0 0,1
0,2 1,8
1,5

%
%

0,3
1,0 0,4 1,6
0,5
0,5
0,6 1,4
0,0 0,7
0,8 1,2
0,5
0,9
1,0 1,0 1,0
01/2007 01/2009 01/2011 01/2013 01/2015 01/2017 02/2016 06/2016 10/2016 02/2017

Source:BloombergL.P.

Insummary,DonaldTrumpsvictoryintheUSpresidentialelectionshadthepotentialforcefor
adramaticchangeinUSpolicieswithfarreachingimplicationsforglobalmarkets.Initiallythequestion
was whether Trumps progrowth agenda was not going to be overshadowed by his other policy
initiatives. More recently, President Trumps reflation hopes have been losing steam. Nevertheless,
marketsarestillgrantingthenewadministrationsomebenefitofthedoubt.Inthisuncertainbackdrop,
wecontinuetosuggestaprudentinvestmentapproach.Worthnoting,wehavenotdiscussedTrumps
trade policy initiatives, simply because they do not seem a priority nowadays, but remaining possibly
quitedisruptiveanyway.Inthemeantime,riskassetscoulddowell,butdemandingactivemanagement
andtheuseofhedgestostayprotectedagainstextremescenarios.

Argentina:StillonaPromissingPath
As noted in our recent piece on Argentina, events over the last few weeks have renewed
reasons to remain cautiously optimistic about Argentine assets, without underestimating the external
risksandthependingdomesticchallenges.Inparticular,aftertwomonthsofstrongtensionandgrowing
politicalthreattothegovernment'seconomicagenda,PresidentMacri'sadministrationseemstohave
regained political initiative. This repositioning, however, is hardly the result of the government's
achievementsbutmostlythereflectionofadividedpoliticalopposition,stillrepresentingtheworstof
thepast,atleastamongthemoreindependentvoters.Infact,economicrecoveryisstilldawdlingand
politicalfragilityislikelytopersistuntilmidtermelections.Butthegovernmentcontinuestohavesome
leverage in the difficult path towards the October elections, particularly favored by the expected
economicimprovementandtheuninspiringopposition.
Determination in the salary negotiation with teachers of the Province of Buenos Aires and a
firm stance maintained by the authorities in the face of the hardest political and union sectors, have
shownagovernmentcommittedtoachangethatmostoftheargentinesocietycallsfor.Tradeunions'
discredit and fear of going backwards have strengthened the government's strategy. This became
especiallytrueafteramassive,independentandspontaneousdemonstrationofthereformingsectors,
whichtookplaceinbigcitiesonApril1st,withthe"supportdemocracy"slogan.Thesedemonstrations
not only eclipsed the faded image created by several consecutive protests, strikes and road blockings

that occurred over the previous weeks, but also strengthened the government's action and helped
improvesocialmood.

Figure9:Confidenceandleadingindicatorsarerecovering

160 65
60
140
55
120 50
45
100
40
80 35
LeadingIndexUTDT 30
60 ConsumerConfidenceIndexUTDT(rhs)
25
40 20
2001 2003 2005 2007 2009 2011 2013 2015 2017
Source:UTDTandSBSResearch

ThisreversalinPresidentMacri'sgovernmentimageafterthedeteriorationofthelastmonths
wasnotfree ofcost, asit entailed certainfiscal tolls.Neither was it powerful enough tosubstantially
modify the economic/political fragility resulting from the official strategy of gradual adjustment and
slowandmixedrecovery.Expenditureinsocialsubsidiesisstillontherise(33%Y/Y),althoughamounts
continuetobemanageable.Butthegovernmenthasalsochosentomaketheeconomicreformagenda
moreflexiblebydelayingtheprogrammedincreasesingasandwaterrates,postponingtheincreasein
transportationfarestoanindefinitefuturedate,andrelaxingitstradeliberalizationpolicy(byimposing
nontariffbarrierstocertainsectors.)
Politicalfragilityshouldbeexpectedtoremainthedominantbackdropuntiltheelections,but
withapositivebiasinfavorofthegovernment.Thiscrumblybutyetimprovingpoliticalpathwouldbe
supportedbyatleastfewfactors.First,aneconomicpolicythathasstartedtoreappoliticalbenefitsin
terms of activity recovery, although not yet convincing enough to guarantee strong support for the
government.Second,theabsenceofanyalternativeleadershipthatcancapitalizethegovernment'slack
of results and the current demand for change. Third, the continued radicalization of some opposition
sectorsseekingtogainexposure,whichtosomeextentfavorstheofficialelectoralstrategy.Andfourth,
the growing tension between the political goal of succeeding in the elections and the needed
implementationofastructuralreformagendatosupportthecurrenteconomicstrategy.

Figure10:Purchasingpowerandfiscalimpulsetobetherecoverydrivers

110 FiscalAccount,12MAggregate,Inflation
20 Moderate growthexpectedgoing
Adjusted
forward(lowbaseforcomparison)
105 FiscalIncome(exinterests)
15
FiscalExpense
100
CapitalExpense
10
95
5
90
%

0
85
5 80

10 PurchasingPower
75
FiscalSpendingRealTerms
15 RetailSales 70
01/2010 05/2011 09/2012 01/2014 05/2015 09/2016 12/2015 03/2016 06/2016 09/2016 12/2016 03/2017
Source:MECON,FYE,andSBSResearch

 Challengesdoremain,with2H2017anticipatingincreasingpoliticalconfrontationaheadofthe
midterm election, and 2018 embodying the real test to start adjusting fiscal imbalances. In the
meantime,inflationinMarchandAprilsurprisedontheupsidebutthegovernmentremainedfirminits
antiinflationary effort, even hiking interest rates from already elevated levels recently. This will
inevitably bring escalating labor market confrontation ahead of the October elections but the
governmentseemsconvincedthisisabattleworthfighting.Delaysintariffincreaseswillnevertheless
help inflation deceleration between now and the elections. A recovering economy should somehow
tamepotentialconflicts,whileadeclininginflationlaterintheyearshouldhelpgainfurthercredibility.
The latter, however, is unlikely to prevent further real peso appreciation as the byproduct of tight
monetarypolicyandrelaxedfiscalspending.

Portfolio:PrudentEMwithArgentinasBiasContinuing
The backdrop discussed above does not present an immediate or significant risk to global
recovery. It, nevertheless, highlights pending uncertainty regarding economic policy and identifies
potential market disruptions ahead. Thus, the investment environment still justifies the prudence,
simplicity,andnimblenesscalledforinourpreviousedition.Thisisexactlywhatwehavebeendoingin
thelastcoupleofmonthswithourSBSCrecimientoFCI,firstdescribedinourLetterV1,#1,onJune2016.
AftertrimmingdurationinourcoreLatinAmericansovereignandcorporatedebtportfolioearlyonin
the year, we decided to take on more risk in the wake of the first Obamacare failed voting, cutting
protectionagainstadditionalincreasesinglobalrates,andreducingourequityposition.Inaddition,we
increased our stake in ARS LEBACS once again, while actively managing ROFEX coverage. All these
changes resulted in a 6% return YTD (net of fees), a superior performance of our portfolio vis a vis a
weightedArgycurveandtheEMBI.

Figure11:SBSCrecimientovsArgiecurveandEMBI

108

106

104

102

100
SBSCRECIMIENTO
98 ARGIECurve
JPEICORE
96

94
07/2016 09/2016 11/2016 01/2017 03/2017 05/2017
Source:SBSandBloombergL.P.

Looking forward, while doubts on the US and the global scenario persist, holding core mid
duration USD EM debt, with an important Argentine bias, seems to remain a good investment
proposition.InArgentina,weparticularlylikelongLETES,DISCOS,andPARSintheUSDcurve,asmid
durationbondslookrelativelyexpensive.Wealsoliketoaddsomeyieldbyholdingselectedsubnational
and provincial debt, particularly City of BA 27s, Province of BA 21s, 23s, and 24s, and Cordoba 21s.
Amongcorporates,wepreferYPF25s,PAMPA27s,andALBANESI23s.OnArgentineARSwestillfavor
shortLEBACS,andsomeCPIlinkerswhileinflationremainshigh,orforanothermonthorso.Thispeso
positionisaccompaniedbyactivehedginggiventheARSlevelandtheCentralBankrecenthintthatthe
authoritiesmightbeincreasinglyuncomfortablewithastrongerpeso.OnLatam,wemaintainabiasin
favortheusualhighcreditsuspectintheregion,withanewbetonChilesSMU.Furthermore,wemight
add some Argentine and Brazilian equities to that portfolio, but only strategically, as we fear global
equityvaluation.Nevertheless,afterthismorningnewsonBrazil,wewouldberathercautiousBrazilian
assets,expectingadelayedprogressinthereformprocess.Finallywewouldincludesomeglobalequity,
credit,andFXvolatilityprotectionasadefensivetacticamidhighglobaluncertaintyandtheviewthat
globalratesandassetpricevolatilityhavemorespacetorisethanotherwise.

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OTHERREPORTS
ArgentineSovereignDebt Argentine CorporateBonds
ArgentineSovereign.DollarLinked ArgentineProvincial/MunicipalBonds
ArgentineEquitySharePerformance ArgentineMutualFunds
ArgentineEquityValuation PrimaryIssuanceCalendar
Equity,Commodities,FX&Rates ROFEX(FX)

S&PTopManagersAward
ByRevistaApertura

Formoreinformation,pleasecontactus:
(5411)48941800

ASSET INVESTMENT TRADING

MANAGEMENT STRATEGY
LeandroTrigo GustavoCaonero JorgeMiteff
Int.220 Int.160 Int.147
lt@sbsfondos.com gc@gruposbs.com jm@gruposbs.com
DaminZuzek,CIIA SebastinCisa,CFA
Int.223 Int.116
dz@sbsfondos.com scc@gruposbs.com
CristianBrau,CFA MariaLauraSegura
Int.218 Int.115
cb@sbsfondos.com mls@gruposbs.com
EmilioMuia FranciscoBordoVillanueva
Int.120 Int.114
em@sbsfondos.com fbv@gruposbs.com
GustavoGiugale
Int.132
gg@sbsfondos.com

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