Why care about Argentina?

We've heard dozens of fund managers, Wall Street analysts, and private bankers ask this question. After all, Argentina's weight in the indices has virtually vanished, and daring to add Argentina risk, could cost portfolio managers their jobs. So why bother?

Yet, Argentina was one of the best-performing equity markets in 2013. The MSCI Argentina climbed 64% in a year when all Latin American markets lost 16%.

This stellar performance did not get much media attention. However, the country managed (it always does!) to regain the headlines for what it does best: go wrong. The Argentine economy is no longer growing, the government is running a deficit of 5% of GDP that is almost entirely financed with money printing, inflation has soared to nearly 30%, and the peso has lost 36% of its value in the last twelve months.

Argentine citizens have learned their lessons the hard way. They know that money printing is a highway to crisis, so they seek to shelter their spare pesos in assets that hold value, like real estate, cars, and, ultimately, the supreme shelter of them all: the US dollar.

The greenback may have its problems at home, but it has never betrayed its Argentine holders. Argentines are prohibited from saving in foreign currencies, and all foreign exchange trades must clear through the central bank, whose supply of dollars is shrinking. The Argentine central bank has lost $23 billion in reserves in the last three years.

Naturally, Argentine citizens have found ways to circumvent these rules, giving rise to a parallel peso/dollar exchange market that exists outside of official control.

OK, that's a lot of bad news. So the question becomes: How was the Argentine market able to rally amidst all these catastrophes?

The answer is simple: They are coming to an end.

In the October 2013 mid-term elections, the incumbent government scored 24 percentage points less than in 2011, inflicting a mortal wound on Cristina Kirchner's reelection bid. That alone filled the air with hope and encouraged some audacious investors to buy Argentine stocks, sparking a fast and furious rally, which peaked in early December.

Since then, the market has been heading south. Inflation seems to have accelerated in recent months, and wages are losing purchasing power fast. Workers are threatening to strike, and there have been reports of looting and deaths in several provinces. Moreover, the parallel (black market) exchange rate soared to 70% above the official exchange rate.

In the meantime, the president underwent brain surgery. Nobody stepped up to control the situation, resulting in poor and often contradictory policy responses to the rapidly deteriorating economic and social landscape.

For example, a few weeks ago, the head of the Argentine tax revenue agency ("AFIP") announced a hike on real estate taxes. A few hours later, the chief of Cabinet denied the news. One day later, the AFIP reaffirmed there would be a tax hike. The next day the minister of Finance said that he had direct orders from the president that there would be no tax hikes.

Three high-ranking individuals squabbling with each other is a sign of incipient anarchy—and not the benign type.

Stocks could not escape the scare, and the MSCI Argentina is now 25% below its early-December peak. That retracement offers the chance to take a fresh look at Argentina, without the anxiety of having to chase a rally.

Despite its "frontier" status in equity indices, Argentina is a far cry from a true frontier country. It is the second-largest economy in South America and the third-largest in Latin America. It has the largest GDP per capita in the region, and has historically had a larger middle class and a more educated population than any of its neighbors.

More important for equity investors, though, is the extraordinary resilience of the corporate sector. Despite having been pummeled for over a decade with tax hikes, fixed prices, negative regulation, the virtual prohibition on payment of dividends, and all sorts of verbal compulsion, Argentine companies have demonstrated a tremendous ability to adapt. They've streamlined to protect margins and paid down debts to prevent succumbing to bankruptcy as a result of either inflation or currency crisis.

With virtually no leverage on their balance sheets, Argentine equities trade, on average, below book value. That alone puts them on our radar. Further, these companies are not allowed to adjust their financial statements for inflation. That makes things very interesting: After six years of around 20% inflation, balance sheets may be underestimating their assets' true value by as much as 50%.

Bolstering that conclusion is the fact that similar assets in comparable countries are priced much higher. The market tends to pay just 50% or less for Argentinian assets than it would for those same assets elsewhere. Whether mobile subscribers, cable TV subscribers, barrels of oil, or GWh of electricity, the equity market puts a large discount on assets if they are located in Argentina. It's not rare to see public Argentine equities trade cheaper than even valuations paid in private equity deals.

With a long-term view, Argentine equities look very cheap. And you needn't dig deep or participate in complicated local-currency trades to find value. Some of the most compelling opportunities trade in ADR form on the NYSE. In particular, we like oil concerns YPF (NYSE:YPF) and Petrobras Argentina (NYSE:PZE). In the TMT sector, we like Telecom Argentina (NYSE:TEO) and Grupo Clarin (London Intl SE:GCLA). And in the banking sector, we like Grupo Galicia (Nasdaq: GGAL).

In a recent report, a prestigious Wall Street firm concluded that Argentina is the cheapest equity market in the world, in both P/E and P/BV terms. Further, Argentina was the only country in all of Latin America in which EPS revisions for 2014 were positive in the last three months. However, they also concluded that investors should be "underweight" Argentina, because it deserves the discount due to political risk.

Here's the bottom line: The countdown to political change started three months ago. And while we must cross an 18-month desert before getting to that change, we think the upside is worth it. The ride will likely be rough. But you do not invest in Argentina to expect conventional returns. On our way to political change, we expect to double or maybe triple our money.

Claudio Maulhardt is managing partner of Copernico Capital Partners, a dedicated emerging-markets manager with a focus on Latin America. For more information on Copernico, email info@copernicofunds.com.

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