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Emerging economies have been performing quite poorly due to feeble demand, lower commodity prices, struggling currencies, increasing chances of tapering and further dollar appreciation.

Among these, Argentina, often overlooked by investors, appears to be rebounding after a year of struggle on both economic and political fronts. The economy was suffering from weak exports, lower demand, poor grain harvest, high inflation and political disorder (read: Avoid These 3 Emerging Market ETFs).

Inside the Rebound

The Argentine economy has shown signs of improvement of late thanks to increased public spending ahead of the mid-term election in October, a rise in auto production, and a record grain and soybean harvest. Additionally, some significant data points have been encouraging, reflecting the turnaround in the economy.

Economic activity, as represented by the EMAE, climbed 7.8% in May, up from 7.1% in April and well above the market expectation of 6.1%. This marks the fastest growth since October 2011.

On the other hand, the trade surplus widened 26.9% in June to $1.16 billion on the back of strong exports for grains and oilseeds. Exports climbed 8% while imports grew a modest 5% in the month.

Argentina’s economy – the third largest in Latin America after Brazil and Mexico – grew 3% in the first quarter of 2013, double than the fourth quarter of 2012 and higher than the expected 1.9%. President Cristina Kirchner projects the economy to grow at least 3.5% this year, up from 1.9% seen last year (read: Time to Buy These Top Ranked Latin America ETFs). 

Inflation Remains Big Problem

Inflation has been the major issue for Argentina over the past couple of years. Currently, ‘official’ inflation is around 11.2% although unofficial reports put the real figure much higher, closer to 25%, one of the highest in the world.

Obviously, this is far too high to promote confidence in the economy and given that the current president has vowed to push for more employment over reducing inflation, many are worried that this trend could continue well into the future.

Argentina ETF in Focus

Despite high inflation, investors are showing interest in the First Trust FTSE Argentina 20 ETF (ARGT), the only way to target the nation, given its ongoing recovery and the related optimism.

The ETF tracks the FTSE Argentina 20 Index, which measures the performance of the 20 largest and liquid companies that directly participate in the Argentine economy. The fund has amassed just $4.3 million in its asset base and trades in average daily trading volume of nearly 3,000 shares. The product charges 75 bps in fees and expenses.

The product gained impressive 9% so far this month, clearly outpacing the broad emerging and developed market funds. Emerging market funds such as (EEM - ETF report) and (EFA - ETF report) added just 0.7% and 2.2% while the broad market fund, SPY, lost 1.7% in the same period. ARGT is up over 11% in the year-to-date period (read: 3 Top Ranked International ETFs Still Worth Buying).

We think the Argentina ETF could be poised for a further move in the coming months, based on both technical and fundamental factors described below. Further, ARGT currently trades 40% below the 2011 peak while EEM and EFA are below their peaks at 21% and 4%, respectively. This indicates that there could be more upside potential in the short term for ARGT.

Technical Look

The fund currently made its new high of $19.33 and its short-term moving averages have managed to stay above the long-term levels. The 9-Day SMA is now comfortably above the longer-term 200-Day SMA, suggesting a continued bullish run for this ETF.

Meanwhile, the fund is accompanied by high volume of late. This is further confirmed by an upswing in the Parabolic SAR, although this figure should definitely be monitored closely.

 

Fundamentals

The fund provides exposure to a small basket of 20 stocks with high concentration level in its top 10 holdings with over 78% of assets.

Investors should note that the product has hefty allocations to the top two firms – Tenaris (TS - Snapshot Report) and Mercadolibre (MELI - Snapshot Report) – at 20.42% and 19.50%, respectively. This suggests that company specific risk is too high and the top two firms dominate the returns of the fund.

Nevertheless, the recent outperformance in the ETF was driven by two of its five sizable holdings – Telecom Argentina (TEO) and Banco Macro (BMA - Snapshot Report). Both have surged over 23% and 26%, respectively, so far in August. The fund allocates at least 5% of total assets in both the firms.

The ETF is skewed towards small securities as these account for 44% of total assets, while large and mid caps take the rest with equal weightings. From a sector look, energy takes the biggest chunk, followed by technology, materials and financials, so there is definitely a tilt towards lower risk sectors (read: The Best ETFs in the Market's Top Sector).

Further, the Argentina ETF looks cheap at current levels compared to many other emerging funds given its low P/E of 14.17 and P/B of 1.44. This low valuation along with the low sector risk is also responsible for the recent surge in the ETF.

Bottom Line

To sum up, although the Argentine economy is showing some signs of improvement, it still has a long way to go. Investors should note that the overall outlook for Argentina is still quite negative and that some more pain could be in store for this nation given high levels of inflation.

We currently have a Zacks ETF Rank of 5 or ‘Strong Sell’ rating on ARGT (see more in the Zacks ETF Center). This suggests that the longer-term picture is still very weak for this fund, and that investors should not be fooled by this recent surge.

As such, investors should look at other markets in Latin America – or at least broader emerging market funds – for exposure, rather than taking risk on in an unlikely rally continuing in Argentine shares. While a further move higher in the near term is definitely possible in this beaten down ETF, the long term prospects are poor at best, suggesting that great caution needs to be taken when investing in this volatile market.

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