Equity Strategy: A Short-Term Rally Is Impending

Although w e believe that the Chilean economy's heavy exposure to the long-term trend of lower metals prices and weaker demand from China for copper exports will further weigh on the country's benchmark IPSA equity index over the coming months, we are becoming increasing ly constructive towards the index for a near-term bounce for reasons both fundamental and technical . Fundamentally, our Commodities team has adopted a positive short-term outlook for metals prices, underpinned by a glimmer of optimism towards Chinese demand prospects for the coming months following suggestion of an impending 'mini-stimulus,' and better than expected manufacturing PMI and import figures from China for July ( see 'Temporary Reprieve For Metals,' August 8).

Copper prices have broken through resistance at US$7,000/tonne, and with sentiment towards metals and mining companies having collapsed to bearish extremes in recent months, with net speculative short positions dropping below 2009 levels following the global financial crisis, the recent positive data from China looks set to spur a short-term relief rally. Moreover, global copper inventories have begun to fall from early 2013 highs, suggesting an easing of downward supply pressures ( see chart). While the IPSA is not as heavily weighted towards basic materials as other industrial metals exporters in the region, such as Brazil and Peru, a jump in metals prices is still likely to improve sentiment towards the economy overall, boosting the performance of equities across most sectors.

From a technical perspective, after a broader double-top reversal appears to have played out on the IPSA, the index has broken through short-term support-turned-resistance around 3,700, and there could be upside of around 9.5% before a test of neckline resistance at 4,100 ( see 'Chilean Equities Poised For A Bounce,' July 22). We highlight that a bullish divergence has formed on the daily relative strength index (RSI), suggesting the current downtrend may be overstretched. A break at 4,100 would be a highly bullish signal, indicating additional gains. Moreover, valuations on the IPSA have cheapened to a PE ratio of 18.8x, the first time the PE ratio has dropped below the five-year average of 19.7x since late 2011.

Watching For Confirmed Close Above 3,700
Chile - Benchmark IPSA Equity Index And MACD & RSI (Daily)

Although w e believe that the Chilean economy's heavy exposure to the long-term trend of lower metals prices and weaker demand from China for copper exports will further weigh on the country's benchmark IPSA equity index over the coming months, we are becoming increasing ly constructive towards the index for a near-term bounce for reasons both fundamental and technical . Fundamentally, our Commodities team has adopted a positive short-term outlook for metals prices, underpinned by a glimmer of optimism towards Chinese demand prospects for the coming months following suggestion of an impending 'mini-stimulus,' and better than expected manufacturing PMI and import figures from China for July ( see 'Temporary Reprieve For Metals,' August 8).

Watching For Confirmed Close Above 3,700
Chile - Benchmark IPSA Equity Index And MACD & RSI (Daily)

Copper prices have broken through resistance at US$7,000/tonne, and with sentiment towards metals and mining companies having collapsed to bearish extremes in recent months, with net speculative short positions dropping below 2009 levels following the global financial crisis, the recent positive data from China looks set to spur a short-term relief rally. Moreover, global copper inventories have begun to fall from early 2013 highs, suggesting an easing of downward supply pressures ( see chart). While the IPSA is not as heavily weighted towards basic materials as other industrial metals exporters in the region, such as Brazil and Peru, a jump in metals prices is still likely to improve sentiment towards the economy overall, boosting the performance of equities across most sectors.

Relief Rally For Metals
Chile - Three-Month LME Copper, US$/tonne (LHS) & Global Copper Inventories, Tonnes (RHS)

From a technical perspective, after a broader double-top reversal appears to have played out on the IPSA, the index has broken through short-term support-turned-resistance around 3,700, and there could be upside of around 9.5% before a test of neckline resistance at 4,100 ( see 'Chilean Equities Poised For A Bounce,' July 22). We highlight that a bullish divergence has formed on the daily relative strength index (RSI), suggesting the current downtrend may be overstretched. A break at 4,100 would be a highly bullish signal, indicating additional gains. Moreover, valuations on the IPSA have cheapened to a PE ratio of 18.8x, the first time the PE ratio has dropped below the five-year average of 19.7x since late 2011.

The Bleeding May Temporarily Stop
Chile - Equities Total Return By Sector, %

Fallen A Long Way

The poor performance of Chilean equities in the year-to-date highlights that market sentiment has broadly aligned with our long-held below consensus view for 4.3% and 4.7% real GDP growth in Chile in 2013 and 2014 respectively ( see 'Consensus Beginning To Catch On To Slowdown View,' July 30) . Indeed, the IPSA is down 12.5% since the start of the year , with no single sector having escaped losses . Basic mater ials and industrials stocks have sold off 31.5% and 24.1 % respectively, illustrating how cooling demand outlooks for a number of Chile's key export markets - China, Japan, and Brazil - have taken a toll on Chilean companies' share prices . Moreover, t he vast outperformance of consumer and technology stocks in 2012 and early 2013, which helped to prevent a sharper sell-off in the index until March, collapsed in recent months as a weaker currency and slowing economic activity weighed on those sectors, as well.

Valuations Sinking Below Five-Year Average
Chile - Benchmark IPSA Equity Index (LHS) & PE Ratio (RHS)

Rising Industrial Exports Could See Equities Follow Suit

Ho wever, in the wake of the afore mentioned sell-off in industrial stocks over the last several quarters, we see significant upside potential in this sector over the coming months , given the divergence between rising exports and the still sinking performance of industrial stocks . Indeed, i ndustrial exports in Chile in July marked the largest yea r -on-year gain ( 11.4% ) since June 2012, and the trend on industrial exports has been positive since February , with higher highs and higher lows . Empresas Copec , an energy, forestry, and logistics company that is the highest weighted stock on the IPSA , also posted its strongest quarterly earnings-per-share performance in Q113 since Q211 , bolstering our optimism for this sector .

Fundamentals Point To A Bounce For Industrials
Chile - Industrial Exports And MSCI Industrials Index (LHS) & MSCI Industrials Index, Monthly (RHS)

Moreover, from a technical perspective, the MSCI Industrials index is oversold on the monthly chart and is approaching multi-year support around 200, where it could be primed for a bounce. A move towards 300, which would still leave the index well off of its highs during the rally in metals prices from 2009-2011, would imply substantial gains of around 50%. Valuations in this sector are also the lowest on the IPSA at 11.7x.

Strengthening CLP To Boost Consumer Stocks
Chile - Exchange Rate, CLP/US$ (LHS) & MSCI Consumer Staples Index (RHS)

Consumer Stocks Could See Gains

We also see fundamental and technical reasons to be optimistic about the performance of consumer stocks over the coming weeks. R ising metals prices , along with a favourable technical picture after a bounce off key trendline support around CLP516.00/US$, are likely to see the Chilean peso continue to strengthen towards CLP490.00/US$ in the coming weeks, from CLP 506.37/US$ at the time of writing, providing a boost to consumer purchasing power. Moreover, unemployment dropped to 6.2% in July, from 6.5% the month prior, and inflation remains anchored solidly below 3.0% y-o-y. Despite a series of poor monthly readings on Chile's economic activity index this year, retail sales have c ontinued to hold up, averaging 9.9 % y-o-y year-to-date. After a false break below support at 295, we believe a rally towards 330 is now likely on the MSCI Consumer Staples index .

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Sector: Country Risk
Geography: Chile
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