Equity Strategy: Major Chart Damage Suggests Further Losses On The Cards
Following a poor performance in 2013, Chilean equities have seen a substantial sell-off to open 2014, with the benchmark IPSA equity index having broken through support at 3,500 on January 27. We had previously highlighted 3,500 as a key level, and we believe the break lower indicates further losses are likely in the coming months. With the technical picture providing little guidance in the near term, we do not rule out a correction all the way to the 2,250 level, implying a potential 33.6% drop from 3,387, where the index is currently trading. Although valuations on the IPSA are now low by historical comparison, with the price-to-earnings ratio at 15.7x, below the 10-year average of 19.4x, such a sell-off could be warranted on a fundamental level. Indeed, negative sentiment towards Chilean equities has been based on a number of factors, which we believe are likely to see headwinds for company earnings persist in the coming months. First, economic activity expanded by just 2.8% year-on-year (y-o-y) in both October and November 2013, down from an average of 4.5% y-o-y from January to September. As such, we believe there are growing downside risks to our forecast for real GDP to expand by 4.2% in 2014, only a slight slowdown from our estimate of 4.3% in 2013 ( see 'Economic Growth To Cool On Weak Investment', January 10).
Second, Chilean assets remain highly correlated with the price of copper, which has fallen recently and is now testing key trendline support around US$7,055/tonne at time of writing. We maintain our view for a structural deceleration in the Chinese economy to continue in 2014, and have a bearish medium-term metal price outlook - we forecast copper prices to average US$6,800/tonne in 2014, compared to Bloomberg forecasts of US$7,000/tonne. While the IPSA had broadly traded sideways through the first three weeks of the year, it was the release of weak manufacturing data from China on January 22 that sent copper prices and, by extension, a number of Chilean stocks, plunging.
Third, many of the largest Chilean companies have operations throughout Latin America, and are particularly exposed to weakness in the key markets of Argentina and Brazil. With regards to the former, Argentina's recent decision to temporarily lift its currency controls, leading to a 13.7% devaluation of the official exchange rate on January 23, is likely to severely weigh on domestic demand, hurting major Chilean retailers such as Cencosud and Falabella. Meanwhile, in Brazil, the central bank's aggressive hiking cycle to stem inflation will feed through to slower economic growth, informing our forecast for real GDP to expand by 2.4% in 2014, only slightly stronger than our estimate of 2.3% last year.
|Next Stop 2,250?|
|Chile - IPSA Equity Index|