Fixed Income

EMD Relative weekly notes: Week Ending January 25, 2019

Week Ending January 25, 2018

01/28/2019

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

We have previously written about why we were not investing in Venezuela, primarily as an exercise in explaining how we make decisions in EM investing. This turned out to be a good call—bonds went from roughly 27 cents on the dollar in March 2018 to a low of 15. In the past month, bond prices have soared back to 24, rising over 30% this month. Is there a case for Venezuela now given the popular perception that the corrupt regime is on its last legs, and have we been mistaken?

Will the regime crumple this year? Very highly likely. Are bonds a buy? From our perspective, almost certainly not.

With no interest being paid now or in the foreseeable future under the best of circumstances, bond prices are lottery tickets acting as a proxy for regime change odds. Those odds are clearly higher now but the rules of the game in Venezuelan investing have not changed. The capacity to generate revenue continues to decline, the economy continues to careen to failed state status, and the institutions necessary to deliver a recovery continue to degrade with a massive brain drain. In other words, so much is uncertain that anyone attempting to dimension the odds for the aftermath of political change, much less the recovery value for bonds, is just guessing.

The timing of when those uncertainties take over from the current optimism based on recent news as a driver of debt prices is also unknowable. There should be no question that those holding the lottery ticket at the right time have simply been the beneficiaries of luck. Markets being what they are, virtually all temporary winners will explain their good fortune as an offshoot of sound analysis. Any fair observer should realize that cannot be possible under
the circumstances existing prior to the rally.

Anyone with a heart wishes for the swift removal of the regime, and a reconstruction that restores stability and a reasonable shot at prosperity for the people of Venezuela. Anyone with a familiarity of behavioral finance must conclude that gambling on that outcome is not worthy of the capital of their clients, in our view.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.