CONTEXT

• After the initial euphoria, local assets have been giving back an important part of the post plebiscite gains. Profit-taking, buying on the rumor and selling on the news, continuing political and institutional uncertainty, etc., are among the reasons most commonly used to explain the reversal. None of them alone, nor all of them together, are sufficient to understand the market reaction as the week progresses.

• The plebiscite should have a positive impact on the markets, under the assumption of lower uncertainty and risk premiums in the future due to the expectation of a more moderate new constitution, and probably also a more moderate and gradual path for the government's main economic reforms (especially the pension and tax reforms).

• However, just as institutional political uncertainty seems to be moderating, economic uncertainty, not only local but also external, appears to be the main concern in the coming months.

• Locally, an economic recession in 2023 is already part of anyone's baseline scenario, reaffirmed by the IPOM presented by the Central Bank this week, but perhaps what still represents the greatest risk to financial stability is the persistence of inflation and unanchored expectations, which would require further tightening, with an expected terminal rate of 11.5%, in principle.

• The central scenario projections offered in the IPOM consider that the rate of price increases will decline in the coming months and annual inflation will begin to fall. However, the risk of observing a much more persistent inflationary phenomenon is a concern for the Council. If realized, this could lead to greater monetary tightening, outside the upper limit of the TPM corridor.

• On the international front, between the energy crisis in Europe, the real estate crisis in China, and tighter financial conditions to cope with the highest inflation in more than 40 years, it is becoming increasingly difficult to defend the thesis of "softlanding".

Scope for local assets

1️⃣ RISK PREMIUM

• While deteriorating macroeconomic fundamentals are likely to have played a role, the widening of Chile's CDS spreads also reflects a significant accumulation of the political risk premium.

• Overall, while the road ahead is likely to be bumpy, we believe this risk premium may begin to diminish in some Chilean assets . We remain more cautious on CLP, given the tailwinds currently supporting the dollar overall globally, as well as the more direct implications of continued upward inflationary pressures for the peso.

• Comparing Chile's sovereign spread to different benchmarks shows that, although Chile has maintained its A rating, as well as a stable outlook from two of the major rating agencies, which likely implies little risk of a downgrade to BBB in the near term, its sovereign spread has moved away from levels common to its A-rated peers. Meanwhile, as nearly two years of constitutional uncertainty have passed, the sovereign spread in Chile has widened to operate in line with BBB-rated sovereigns.

• From another perspective, despite Chile's A rating, its 5-year CDS spreads are in the middle of the BBB range and significantly wider than the A-rated spread .

2️⃣FIXED INCOME

• In fixed income, given the context of US sovereign prime rates that continue to rise sharply, for now it is difficult to think of an easing of local prime rates, especially nominal ones.

• We believe it is not necessary to take duration risk today. Over the last 12m the rate curve has been sharply upward, especially in maturities close to 1 year, giving room for attractive risk/return positioning (nominal YTM around 12%).

• The market continues to project high inflationary accruals for the following months, maintaining the attractiveness of instruments indexed to the UF. The real curve with a duration of around 2 years is where to position, thinking of continuing to hedge against inflation.

3️⃣ VARIABLE INCOME

• Despite the IPSA's outstanding performance so far in 2022 (+24% in USD vs. +.0% for Latam and -19% for the MSCI World), in contrast to global equities, we continue to see room for further recoveries in a context of valuations that remain attractive both in absolute terms and relative to emerging markets and corporate results, which continue to surprise on the upside.

• Even before the Plebiscite result, the IPSA was already outperforming international comparables, which we expect to be maintained in the future, mainly due to the strength of certain commodities (especially Lithium) and its "more value" composition. Valuations continue to be very attractive and the dynamics of corporate results are favorable.

• Similarly, the outcome of the Plebiscite could help decompress Chile's risk premium, which as mentioned above is abnormally high. This would drive a re-rating of multiples and change the excessive punishment of the IPSA by the market.

• Over the medium term, the market should look for a balance between easing (or not) pressure on valuations, as well as on the reaction of corporate earnings to downward revisions in economic growth (the consensus projects a drop of around -10.6% in EPS over the next 12 months, and -17.6% y-o-y in 2023).

• In this context, our projections are for the IPSA to rise to around 6,500 points in 12 months, which is equivalent to an increase of ~17% from current levels (data as of the close of September 7, 2022).

4️⃣ TYPE OF CHANGE

• Given the deterioration of terms of trade, the international strength of the dollar, and the bets against the peso by foreign investors (US$10,000 mm), current equilibrium levels are around $900. However, as upward pressures diminish, an exchange rate closer to US$850 is expected, which is consistent with a TC of equilibrium with respect to international comparables after the social outbreak.

For more information, please see the attached report HERE.

Humberto Mora

Assistant Investment Manager Finance and Business Finance and Business Brokerage Firm