Thu | Jul 19, 2018

Walter Molano | Chile: A mixed bag as market herd disperses

Published:Friday | December 16, 2016 | 12:00 AM
President of Chile, Michelle Bachelet.

Spring is probably one of the prettiest seasons in Santiago, Chile. The white-capped Andes are clearly visible in the distance, as the city begins to emerge from the long winter hibernation.

Unfortunately, the onset of the dry season leads to wildfires on the outskirts of the capital, and a thick smog soon envelopes the city and persists for most of the summer months.

It is within this context that the residents escape each weekend to the sunny beaches of Valparaiso, the fresh breeze of Zapallar or the verdant vineyards of the Maipo Valley.

The change of seasons is always a mixed bag, something bad along with something good. The same goes with the new global economic outlook. The election of Donald Trump sent powerful reverberations across the nation's boardrooms and corporate headquarters.

Ensconced in the far reaches of the southern hemisphere, they were far away from the centre of action and very reliant on Wall Street research reports and media outlets. Most of these sources missed the Trump victory by a wide margin. As a result, they were caught wrong-footed by the outcome.

Clearly, the new economic scenario calls for a large expansion of United States government spending, an increase in economic activity and an accompanying rise in the inflation rate.

Treasury yields have already soared, and some pundits believe that by this time next year they will be twice as high.

It is important to note that not everyone shares this opinion, and there are some notable analysts that believe that rates will return to their lows. US Treasury analysts tend to have herd-like behaviour, but there has been a dispersion of views since the elections.

Nevertheless, Chilean bond spreads will suffer if Treasuries continue to their upward trajectory. This is making many of the pension funds, family offices and portfolio managers rejig their positions, reducing duration and shifting their asset allocation. There is a migration of capital into US equities and dollar assets.

Silver lining

At the same time, the Trump cloud has a silver lining. While most commodity prices came back to life in 2016, due to a drop in capex and a subsequent reduction in output, copper prices languished.

The main reason was a huge increase in Peru's copper production. In January, the country's copper output jumped 41 per cent y/y. This was led by a jump in the Cerro Verde mine, which is located in the southern region of Arequipa. There were also large increases in Cusco's Constancia and Junin's Toromocho mines.

However, the expected trillion-dollar increase in US infrastructure spending brought the sector to life.

Chile's firms may not have such easy access to cheap financing as they did over the last few years, but the improvement in metal prices and a weaker currency will allow them to improve their export earnings.

Chile's pace of economic expansion was an anaemic 1.6 per cent y/y in the third quarter, and it should be about the same for the whole year. However, the improving outlook for metal prices could allow the economy to accelerate to 2.4 per cent y/y GDP growth in 2017.

An increase in government spending will also boost the level of economic activity.

The country is gearing up for presidential elections, and the government is doing its part by expanding its spending. The field remains pretty dispersed, with former President Sebastian Pinera leading the pack with a fifth of the vote.

Next on the list is Alejandro Guillier. Currently a senator, Guillier made his name as a journalist and radio personality. He is part of the populist trend that is engulfing most advanced democracies, as the electorate continues to be disillusioned by the traditional political parties and their elites. Most of them have been captured by special-interest groups or become mired in flagrant corruption scandals. This has allowed new faces, many drawn from traditional media or social media venues, to emerge on the national political stage.

The presence of former President Ricardo Lagos in the primary circuit just reinforces this problem. A perennial on the political circuit, the former president continues to throw his hat in the ring, like a bad fashion that never goes away.

The outlook for Chile is a mixed bag of good and bad. The possible shift to higher rates in the US will make it harder for the country to raise capital. Fortunately, a recovery in copper prices and a stronger dollar will improve the economy's ability to export and generate revenues.

It is too early to call the presidential electoral results, but we do not expect that there will be many changes on the economic policy front.

Some of the recent labour reforms will be modified, and there could be some changes in the national pension fund scheme. Nevertheless, the country will continue to be an oasis of relative stability in a region of constant volatility.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.