CONTEXT

• After the initial euphoria, local assets have given back a significant portion of their post-referendum gains. Profit-taking , “buy the rumor, sell the news,” and the continuing political and institutional uncertainty are among the most commonly cited reasons for this reversal. Neither any single factor nor all of them combined are sufficient to explain the market’s reaction as the week progresses.

•  The referendum should have a positive impact on the markets, assuming lower uncertainty and risk premiums in the future due to expectations of a new, more moderate constitution, and likely also a more moderate and gradual path for the government’s major economic reforms (especially pension and tax reforms).

• However, just as institutional political uncertainty appears to be easing, economic uncertainty—not only domestic but also external—is emerging as the main concern for the coming months.

• At the local level , an economic recession in 2023 is already part of everyone’s baseline scenario—a view reaffirmed, moreover, in the IPOM presented by the Central Bank this week—but perhaps what continues to pose the greatest risk to financial stability is persistent inflation and unanchored expectations, which would require further tightening, with an expected terminal rate of 11.5%, in principle.

• The projections in the baseline scenario presented in the IPOM suggest that the pace of price increases will slow in the coming months and that annual inflation will begin to decline. However, the Council notes that the risk of a much more persistent inflationary trend is a cause for concern. If this were to materialize, it could lead to greater monetary tightening, beyond the upper limit of the TPM corridor.

• On the international front, amid the energy crisis in Europe, the real estate crisis in China, and tighter financial conditions aimed at tackling the highest inflation in more than 40 years, it is becoming increasingly difficult to defend the “soft landing” thesis.

Scope for Local Assets

1️⃣ RISK PREMIUM

• While the deterioration in macroeconomic fundamentals likely played a role, the widening of Chile’s CDS spreads also reflects a significant build-up of the political risk premium.

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

• When comparing Chile’s sovereign spread to various benchmarks , it becomes apparent that , although Chile has maintained its A rating and a stable outlook from two of the major rating agencies—which likely implies little risk of a downgrade to BBB in the short term—its sovereign spread has diverged from the levels typical of its A-rated peers. Meanwhile, as nearly two years of constitutional uncertainty have passed, Chile’s sovereign spread has widened to align with that of 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 are significantly wider than the spread for an A rating. 

2️⃣FIXED INCOME

• In the fixed-income market, given that U.S. sovereign benchmark rates continue to rise sharply, it is difficult at this time to envision any easing in local benchmark rates—especially nominal rates.

• We believe it is not necessary to take duration risk at this time. Over the past 12 months, the yield curve has been rising sharply, especially for maturities close to 1 year, creating an attractive risk/return profile. (Nominal YTM around 12%).

• The market continues to project high inflation rates for the coming months, keeping UF-indexed instruments attractive. The real yield curve with a duration of around 2 years is where investors should position themselves if they want to continue hedging against inflation.

3️⃣ EQUITY INCOME

• Despite the IPSA’s strong performance so far in 2022 (+24% in USD compared to +,0% for Latin America and -19% for the MSCI World), in contrast to global equities, we continue to see room for further gains given that valuations remain attractive both in absolute terms and relative to emerging markets, and corporate earnings continue to beat expectations.

• Even before the results of the plebiscite, IPSA had been outperforming its international peers, a trend we expect to continue going forward, primarily due to the strength of certain commodities (especially lithium) and its “more value-oriented” portfolio composition. Valuations remain very attractive, and corporate earnings trends are favorable.

• Similarly, the outcome of the plebiscite could help ease Chile’s risk premium, which, as we mentioned earlier, is abnormally high. This would prompt a revaluation of the market multiples and put an end to the market’s excessive punishment of the IPSA.

• In the medium term, the market should seek a balance between whether or not pressure on valuations eases, as well as how corporate earnings react to downward revisions in economic growth (the consensus forecasts a decline of about -10.6% in EPS over the next 12 months, and -17.6% year-over-year in 2023). 

• In this context, our projections indicate that the IPSA will 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 trading on September 7, 2022).

4️⃣ EXCHANGE RATE

• Given the deterioration in terms of trade, the strength of the dollar internationally, and bets against the peso by foreign investors (US$10,000 mm), current equilibrium levels stand at around $900. However, as upward pressures ease, the exchange rate is expected to move closer to US$850, which is consistent with an equilibrium exchange rate relative to international comparables following the social unrest.

For more information, see the attached report HERE.

Humberto Mora

Investment, Finance, and Business Manager; Stockbroker