ILF - ECH ETF - Things Are Looking Up

2023-12-13 03:01:09 ET

Summary

• The iShares MSCI Chile ETF has underperformed global stocks this year, with uncertainty around the rewriting of the constitution playing a part.
• We touch upon some notable macro cogs that are improving.
• ECH is dirt-cheap from a valuation angle, and the risk-reward on the charts looks compelling.

Not A Great Year, But The Uncertainty Could Abate

The iShares MSCI Chile ETF ( ECH ), a $560m sized ETF, which provides exposure to 27 Chilean stocks has delivered an unremarkable performance this year, providing returns of only mid-single-digits, even as global stocks have delivered returns that are over 3x higher. We covered ECH ETF last in June 2021.

One of the reasons why ECH hasn’t necessarily flourished is because there appears to be a lot of uncertainty surrounding the rewriting of the constitution there. Note that at the end of this week (Dec 17th), there will be a referendum to determine if the populace has accepted the second attempt at rewriting the constitution.

The latest polls suggest that things are very much up in the air, but one way or the other we should get some decisiveness as the Boric Administration had previously stated that this will be the last attempt at rewriting the constitution. Now, even if the latest version doesn’t get a majority vote, and the unideal Pinochet era constitution were to continue to hold, investors interested in Chilean equities can certainly take heart from the clarity they will receive heading into 2024.

Macro Backdrop Poised To Improve

If one can look beyond the shenanigans associated with the constitution reform, it's fair to say that things are looking up for the Chilean economy in the medium term.

After witnessing a -0.3% contraction in Q2, GDP growth in Q3 recovered by +0.3%. In effect on a YoY basis, the growth trajectory improved to +0.6% as against the -0.8% decline in Q2. All in all, whilst 2023 may prove to be a disappointing year, next year is expected to be substantially better. The IMF, the more conservative institution, expects GDP to decline by - 0.5% this year, whereas the OECD is a bit more aggressive, expecting flattish growth this year. Next year though both institutions expect Chilean real GDP to grow by 1.6-1.8%.

One of the key drivers of growth next year could be the export variable which accounts for 35% of Chile's GDP. This year Chilean exports have only grown at 0.8%, but next year it is expected to pick up in a big way and grow by 3% or so.

Within this, one of the key variables to watch is copper exports which recently picked up by +4% in November, after a -9 % decline in the previous month; alongside Peru, Chile accounts for close to a third of the globe’s total copper production, and will no doubt be a key beneficiary in the ongoing thrust of electrification trends around the world.

Water shortages have played a part in limiting copper production in Chile this year, and there are fears that higher mining royalty may dampen the enthusiasm for investments, but still, do also note that the royalty also includes encouraging clauses that are designed to bring down permitting times.

Besides exports, domestically as well, we think the Chilean consumer could be in much better financial health next year. Firstly, note that headline inflation, which stood at hefty levels of over 12% at the start of the year, has been coming down in a big way. It has been on a downward trend for 12 consecutive months, and recently only came in at 4.8%. The IMF now believes that next year’s inflation could well drop to levels of 3.6%, putting it in touching distance from the average 3% levels seen during the pre-pandemic era.

What this also means is that the prospect of real wage growth looks increasingly bright. As per the latest data, average hourly earnings have been growing at a positive pace in recent months, and in August it already stood at nearly 4% . For context, in the pre-pandemic era, real wage growth only averaged 2.1%. This could provide a fillip for household spending next year, which Fitch Solutions believes could hit levels of CLP108.4tn next year (translating to real growth of 3%). Note that this represents a 13% uplift over levels of CLP95.7tn seen during the pre-pandemic year (2019).

We’re also enthused by the shifting stance of the Chilean central bank and how this could potentially boost household budgets and investments in the months ahead. Since July, the central bank has been bringing down its policy rate from elevated levels of 11.25%. As things stand, the policy rates stand at 9%, but the expectation for next year is that it could drop to levels of 3.5%.

Closing Thoughts- Valuation and Technical Landscapes Looks Compelling

Even from the valuation and technical viewpoints, we think ECH offers some promise at this juncture. As per Morningstar data, ECH can be picked up at a P/E ratio of less than 7x . That translates to a massive 50% discount on what global stocks are currently priced at. At that dirt-cheap multiple, investors also face the prospect of superior long-term earnings growth of 12.4% as opposed to a corresponding figure of 10.5% for global stocks.

We also see Chilean stocks as appropriate rotational options for those interested in the Latin American universe. Note that ECH’s relative strength ratio versus a broader Latam portfolio is currently around 30% off the mid-point of the long-term range. Also we’ve now seen three separate instances since H2-21 where the relative strength ratio has dropped below 0.95x, only to quickly rebound (implying favorable prospects for Chilean stocks).

Finally, if one looks at ECH’s weekly price imprints over the last 30 months or so, it’s evident that the product has been chopping along directionless within a certain trading range. As things stand, the current upper and lower boundaries are around the $24 and $32 levels. After taking support at around the lower boundary in October and November, we’ve seen the ETF pick up pace in the following weeks. Encouragingly over the last 2 weeks, we've also witnessed a useful pullback. All in all, if one uses the upper and lower boundaries as guideposts, and gets in at current levels, you're staring at a rather healthy reward-to-risk equation of 1.86x.

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