First, let’s define which metric is best suited to measure a market’s long-term value. FYNSA has always argued that the price-to-book (P/B) ratio is a reliable metric for analyzing long-term prospects, especially in scenarios of greater uncertainty such as the one we are currently experiencing in the local market. The P/B ratio could be defined as the installed capacity that will enable companies to generate average future earnings. If we look solely at the returns for local companies, the outlook appears quite favorable. Accelerating global growth, commodity prices at record highs (in nominal terms), favorable terms of trade, and unprecedented monetary and fiscal stimulus explain a scenario of earnings expansion not seen in the last ten years.

In a bottom-up analysis, examining the expected ROE (return on equity) of the companies that make up the IPSA—weighted by their index weight—we see that it stands at 12–13%. Our analysis considers the lower end of this range of returns and, furthermore, projects growth that is lower than what is theoretically implied, given the variables described above.

If it is not obvious how to compare the impact on earnings between a favorable global economic scenario and a potentially more hostile political environment for companies, how do we capture the greater uncertainty implied by Chilean asset prices?

Our answer to this question lies in the discount rate—or “cost of equity”—that the market uses to value the IPSA. Chile currently has an A credit rating. We initially assume a further deterioration in its credit profile over the medium term, though without losing investment-grade status; in practice, this would bring Chile closer to Colombia’s credit rating, which is currently BBB-. Based on the above, we incorporate into our estimate the higher cost of borrowing that this deterioration in Chile’s credit quality would entail today, based on the levels that the international CDS and sovereign bond markets would require of Chile under these assumptions. We incorporate the higher cost of borrowing—which our stress scenario for the local stock market implies—into our economics team’s estimate of long-term equilibrium rates, and we also factor in the rise in the 10-year Treasury bond yield based on projections from major global investment banks.

Taking all these variables into account, we arrive at an IPSA level of 4,530 points, which is also consistent with a P/B ratio that is roughly one standard deviation below the average for the last ten years.

This stress scenario we’ve modeled incorporates a potential rise of about 10% from the IPSA’s current level. Another additional and complementary question would be: How has the market reacted to situations similar to the one Chile is currently facing? The answer to this question might come from the Peruvian market. Peru’s political and social situation isn’t exactly the same as ours, but it does share quite a few similarities. Today, Chile trades at a 5% discount in terms of P/B (MSCI) relative to Peru, whereas historically it has traded at a 20% premium.