Equity Strategy: Upside Potential In ICT And Utilities

We are bearish towards Chile's benchmark IPSA equity index, as expressed through our view for the IPSA to underperform Mexico's IPC blue-chip index in our Americas Asset Class Strategy ( see 'Bullish Mexico's IPC Over Chile's IPSA', March 20). While the IPSA has rallied by 17.0% since hitting a recent low of 3,369 on January 31, due in part to a period of positive risk sentiment towards Latin American equities, we believe the current rally will run out of steam in the coming weeks.

With the index having held to trendline support at 3,910 in recent trading, we do not rule out some additional upside for the IPSA. However, we believe that key resistance at the 4,100 level will be stiff in the event that it is tested, given weakening economic activity in Chile. Indeed, we recently revised down our 2014 real GDP growth forecast from 3.4% to 3.1%, implying a substantial drop-off from 4.1% real GDP growth in 2013 ( see 'Growth To Slow on Weak Investment And Private Consumption', May 20). Moreover, valuations on the IPSA look unattractive, with the trailing price-to-earnings (PE) ratio at 22.1x, compared to the 10-year average of 19.4x, and corporate earnings stagnating amidst weak economic activity. Should the IPSA bounce off resistance at 4,100, we expect the index would continue heading lower, potentially towards the 3,600-3,700 range, where it has seen extensive trading in recent months.

Performance By Sector

Approaching Stiff Resistance At 4,100
Chile - Benchmark IPSA Equity Index

Equity Strategy: Upside Potential In ICT And Utilities

We are bearish towards Chile's benchmark IPSA equity index, as expressed through our view for the IPSA to underperform Mexico's IPC blue-chip index in our Americas Asset Class Strategy ( see 'Bullish Mexico's IPC Over Chile's IPSA', March 20). While the IPSA has rallied by 17.0% since hitting a recent low of 3,369 on January 31, due in part to a period of positive risk sentiment towards Latin American equities, we believe the current rally will run out of steam in the coming weeks.

Approaching Stiff Resistance At 4,100
Chile - Benchmark IPSA Equity Index

With the index having held to trendline support at 3,910 in recent trading, we do not rule out some additional upside for the IPSA. However, we believe that key resistance at the 4,100 level will be stiff in the event that it is tested, given weakening economic activity in Chile. Indeed, we recently revised down our 2014 real GDP growth forecast from 3.4% to 3.1%, implying a substantial drop-off from 4.1% real GDP growth in 2013 ( see 'Growth To Slow on Weak Investment And Private Consumption', May 20). Moreover, valuations on the IPSA look unattractive, with the trailing price-to-earnings (PE) ratio at 22.1x, compared to the 10-year average of 19.4x, and corporate earnings stagnating amidst weak economic activity. Should the IPSA bounce off resistance at 4,100, we expect the index would continue heading lower, potentially towards the 3,600-3,700 range, where it has seen extensive trading in recent months.

Performance By Sector

We maintain a negative outlook for stocks in the basic materials and industrial sectors, which are most directly exposed to lower average copper prices, and weakening fixed investment and manufacturing output. Moreover, we do not like consumer stocks, which have underperformed the broader index over the past 12 months, given a poor outlook for private consumption ( see more on this below). However, we see upside potential opportunities in the ICT and utilities sectors. Although the rally in Chilean equities since the end of January has been broad-based, industrials and basic materials stocks have underperformed utilities, financials and consumer staples since the start of May, in line with our view.

Materials, Industrials And Consumer Stocks Will Continue To Underperform
MSCI Chile Indices, Normalised May 23 2012 = 100

Weak Fundamentals Will See Current Rally In Consumer Stocks Run Out Of Steam

We maintain a cautious outlook on the performance of Chilean consumer stocks over the next several months due to the sector's weak fundamentals. Real private consumption growth has decelerated for four straight quarters through Q114, as higher inflation, driven by a depreciating peso, has cut into real wage growth, eroding consumers' purchasing power ( see 'Weaker Consumer Poses Downside Risks To Growth', May 1). We expect falling copper prices to spur additional downside for the peso in the coming months, keeping the Chilean consumer under pressure, and Chilean consumer stocks, such as Cencosud and Falabells, tend to correlate closely with movements in the peso ( see 'Falling Copper Prices To Weigh On Chilean Peso', May 19). As such, we do not expect the recent rally in consumer stocks to extend much further in the coming weeks and months.

Consumer Stocks Vulnerable To Further Exchange Rate Depreciation
Chile - Exchange Rate, CLP/USD & Cencosud Share Price, CLP

Bullish Technicals And Fundamentals In The ICT Sector

We view stocks in the information technology (IT) sector as potential outperformers, given our ICT team's forecasts for strong growth in Latin American IT services. In particular, we believe that the Chilean firm Sonda, the largest IT service provider in Latin America, is a company with significant upside potential. Sonda has expanded aggressively across Latin America in recent years in pursuit of growth opportunities, most recently with its acquisition of Brazil-based IT outsourcing services provider CTIS in mid-March ( see 'Information Technology Equities Set To Outperform', March 28). The acquisition nearly doubles Sonda's Brazilian revenue base. Our ICT team believes this bodes well for the firm's financial performance in the coming years, given our forecast for Brazil's IT services market to grow at an average of 9.1% per year to USD15.7bn by 2018 ( see 'Sonda's CTIS Acquisition Reflects Bullish IT Market Outlook', March 19).

Break Higher Points To Additional Gains
Chile - Sonda Share Price, CLP

In addition, Sonda broke through trendline resistance on May 22, a bullish technical signal. Momentum indicators such as the daily relative strength index are beginning to look overextended, suggesting that the stock may consolidate in the coming days. However, we believe the company's fundamentals suggest another push higher is likely over a multi-week timeframe towards trendline resistance around CLP1,500.

Ratio May Re-Test 2008 Lows
Ratio of MSCI Chile Index to MSCI Chile Utilities Index

Utilities Outperformance Has Further To Run

Chilean utilities stocks will continue their recent outperformance against the MSCI Chile Equity Index, and we believe that the ratio of the MSCI Chile Index to the MSCI Chile Utilities Index could continue to head lower, potentially testing the previous low of 5.0x set in 2009 ( see 'Equity Strategy: Utilities Outperformance To Continue', April 11). Fundamentally, our Infrastructure team has identified Chile as among the most attractive countries in Latin America to invest in long term infrastructure projects. Moreover, it has highlighted a strong project pipeline in the energy and utilities sector, with a particular focus on renewables, to meet the mining sector's rising demand for electricity ( see 'Chile, Turkey, South Africa, and China: EM Renewables Hubs', May 21). The two largest utilities companies in Chile, Enersis and Endesa, saw their net incomes rise by 56.3% year-on-year (y-o-y) and 93.1% (y-o-y) in Q413, respectively, bolstering our optimism about the sector's relative outperformance.

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