Mid-Year Outlook International

Focus on diversification and quality

• The market rally since 4Q23 began on the expectation that normalizing inflation would allow the Fed to cut rates (~7 cuts by December 2024) and engineer a soft landing for the economy. Instead, inflation drivers have surprised to the upside for much of the year and growth has been uneven, forcing expectations down to only ~2 cuts for this year.
• In recent weeks, economic data in the U.S. has been surprisingly broadly downward and consumers are showing some signs of fatigue (retail sales, consumer confidence, auto and credit card delinquencies), but with inflation above the Fed's target and the economy not in crisis, the economy is not in crisis. (retail sales, consumer confidence, auto and credit card delinquencies), but with inflation above the Fed's target and the economy not in crisis, the logic that "bad economic data is good data for the market" seems rather questionable to us.
• Rather, we may be approaching the point where "bad data will be bad" for risk assets, with the economy potentially weakening, and inflation could remain stable and above the Fed's target. Even if the Fed were to cut rates, the long-term rate (the discount rate used for risky assets) need not fall at the same pace, given the liquidity squeeze and potentially higher term premia.
• There is therefore a risk that the opposite of the optimistic expectation may occur in the coming quarters: growth slows, inflation remains firm and long-term rates do not fall sharply (risk of stagflation).
• Thus, we believe that volatility in the rates market will continue, especially in the long part of the curveWe therefore believe that volatility in the rates market will continue, especially in the long end of the curve, amid greater fiscal pressures and high inflationary volatility (which could be accentuated in the context of the US elections), which do not justify negative term premia at this point in time.
• In terms of duration, it seems prudent to continue to maintain a fixed income strategy in the short/mid part of the curve (between 3 and 5 years), until there is more evidence of inflation convergence and a "friendlier" monetary and fiscal policy.
• In this still challenging context for the asset class, the RFI had a slightly negative performance during the first half (-0.71%).. Going forward, we maintain our conviction that the coming quarters should be more positive for fixed income, with more muted interest rate risks and historically attractive starting rate levels. The focus on improving quality should allow investors to build resilient portfolios without giving up upside potential.
• In equities, the outsized performance of large cap stocks is masking weakness in other areas of the market. For example, the S&P 500 equal weight has been virtually unchanged over the past 2.5 years, and the Russell 2000 has been moving sideways for even longer, even though we have seen nominal GDP growth of 25% over the past 3 years.
• The momentum factor continues to be the main driver of stock gains, and market concentration is at a 60-year high. Only a small percentage of S&P 500 companies are behind expected earnings revisions for 2024 (top 20 companies with EPS revisions of +18%, versus the rest of the S&P 500, down 6%) and EPS revisions for 2025, the top 20 are up 22% and the rest are revised down by -3%.
• For the time being, equity markets will continue to struggle between higher interest rates and positive corporate earnings dynamics, associated with the strength of the economy, but above all with the potential of AI.associated with the strength of the economy but, above all, with the potential of AI.
• We are maintaining a focus on diversification and quality and a more balanced global a more balanced global strategy to address the highly concentrated U.S. market and unattractive valuations.
• RVI returned +11.37% during the first half of the year, and returns should be more moderate for the second half of the year.
• The dollar is likely to remain strong over a 6 to 12 month horizon, given wider interest rate differentials.. Our bullish USD view is based on two fundamental pillars: the dollar's carry advantage despite being a defensive currency and the persistent outperformance of the US economy.
• Finally, a reference to US election risk. Unlike previous election cycles, when the debate centered on which set of policies would likely be most positive for markets, current scenarios appear to be more neutral, with the potential for significant negative outcomes. A Biden presidential victory would likely be more of the same, as Congress remains gridlocked and limits the passage of transformative new policies. However, a Trump victory could drive substantial changes in areas such as trade policy (e.g., U.S.-China), foreign policy (e.g., Middle East/Israel, Russia/Ukraine, etc.), regulation (e.g., environmental/energy, antitrust) and fiscal/tax policy (e.g., TCJA expiration on December 31, 2025).

Mid-Year Outlook Local

Local assets continue to offer an attractive risk-return profile.

• On the local front, we have started the year with upside surprises in growth (although the economy has lost its initial momentum in recent months). (although the economy has lost its initial momentum in recent months), but also in inflation. The process of monetary normalization by the Central Bank has followed its budgeted course, with the TPM already at 5.75%.
• However, local economic surprisesthe increase in electricity rates y the delay in the process of monetary normalization in the U.S. are likely to result in a slowdown in the process of TPM cuts for the rest of the year, and convergence to a neutral rate (close to 4.0%) would be delayed to 2025.
• On the other hand, we continue to expect higher inflation than the market (inflation would end 2024 at 4.9% and 2025 at 3.8%). (inflation would end 2024 at 4.9% and 2025 at 3.8%).
• Local fixed income closed a positive half year, y we maintain our preference for a short duration strategy with a high indexation to the UF and very good credit quality (AA)..
• Although the level of long rates is high, the risk of negative returns in short periods is much higher, and the rise in electricity rates and higher projected inflation increase the demand for UF-adjustable instruments with maturities up to 2 years, which is the best way to "earn" the new projected inflation and with a "lower market risk".
• Local equities had a half year with positive returns (+3.49%) in local currency, but negative in dollars (-5.92%), quite far from the performance of global equities (+11.37%), although better than Latam markets, which fell 11.52% in dollar terms. The reasons behind that are basically the lingering doubts about China, and a mix of political and institutional risks in the region.
• Going forward, interest rates will apparently no longer be so friendly, but we are betting on the recovery of domestic demand and a still high "valuation cushion". We maintain our IPSA 2024 target at 7,000 points and 7,500 for 2025.
• At the sector level, we maintain a stronger conviction in banks, commodities and consumer products.
• Finally, the global trend of the dollar continues and will continue to be bullish at least until the end of the year, simply because rate differentials favor the dollar (especially against other developed market currencies), and the reality is that all currencies that offer little carry trade are suffering, such as the Chinese yuan, the Japanese yen, and the Chilean peso itself.

We are in a world where carry matters a lot, which continues to leave the peso vulnerable to external flows that use it as a funding currency versus other higher yielding currencies in the region.The more so given that the Central Bank of Chile will continue to cut interest rates (albeit more gradually) versus comparable Latam and developed markets, where they are still generally expected to hold rather than cut rates for the rest of the year.

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Humberto Mora

Investment, Finance, and Business Manager; Stockbroker