By Patricia Gonzalez, Senior Analyst, Emerging Markets Equity; Sunny Bokhari, Associate Product Manager
Ongoing economic reforms in Chile and Argentina could support structural growth and attractive investment opportunities in their consumer discretionary and financials sectors. Chile is experiencing an economic turnaround partly driven by strong demand for copper, its chief export. Attractive equity valuations and a recovering consumer and lending environment warrant a deeper understanding of the country’s investment climate. Meanwhile, Argentina is undergoing transformative economic reforms aimed at reducing fiscal imbalances and controlling inflation. These structural changes could revive the country’s economy.
Chile: Growth Drivers Present a Bright Outlook
Overall, we detected a renewed positive sentiment among local companies and government authorities on Chile’s growth trajectory. Chile is experiencing a wave of optimism, driven by a constructive outlook from corporates and improved visibility following potential changes to its constitution. The country’s new president envisions a stronger role of government in provision of social services and reduced income inequality in the country. One of his flagship policies is overhauling the current pension system by replacing pension fund managers with private investment managers and raising the minimum guaranteed pension provided by the state. He expects the changes to the constitution approved before the end of his term in office and is pushing for a fast-track vote on the pension reform1.
The Chilean economy has had a positive start in 2024, with higher-than-expected growth. The country’s economic activity index was up 4.5% in February, its largest increase in 2 years,2 on the back of strong mining and transportation sector performance. Chile’s GDP is expected to reach 2.8%, which is a significant increase from 0.2% in 2023. The country’s inflation is projected to trend down to 3% and subsequently, interest rates could come down to 4.5-5.0%. We believe this could help stimulate consumption in the economy and lift the economy via demand growth.
Copper and Chile’s Economy
Chile is the world’s largest copper producer and strong demand for the metal typically bodes well for the economy. On top of the current demand for copper as a key metal in energy transition industries, artificial intelligence (AI) demand has the potential to be another pillar to copper’s long-term structural demand growth. AI, which feeds on power from increasingly large data centers that commonly use copper wiring, could propel copper prices higher.
MSCI Chile vs. Copper Price
Source: Bloomberg Finance L.P., J.P. Morgan as of 12/31/2023.
Historically, Chilean equities and copper prices have shown a correlation of 85% in yearly returns in the last 20 years.3 This trend showed a decoupling since October 2019 coinciding with the higher macropolitical uncertainty. We expect the correlation to increase again as political uncertainty subsides and believe a strong upside for copper could be a positive catalyst for Chilean equities.
Attractive Valuations
Chile is currently trading at 7.2x forward P/E, below its 10-year average of 14.0x. Compared to other LATAM countries, we note it is the second most discounted market after Colombia. Given the strong macroeconomic tailwinds, we believe Chilean equities could offer an attractive entry point to investors considering exposure.
Chile Forward P/E vs.10Y Average
Source: Bloomberg Finance L.P., J.P. Morgan as of 12/31/2023.
LatAm P/E Discount vs.10Y Average
Source: Bloomberg Finance L.P., J.P. Morgan as of 12/31/2023.
Revival in Consumer Activity and Lending
Chile is likely to undergo one of the strongest easing cycles in LATAM with an expected rate cut of 375bps by the end of the year. The country is witnessing a recovery in consumer activity that had declined after the end of pandemic-related stimulus and pension payments, with even challenging sectors like department stores showing signs of improvement. We believe the overall lending environment is improving and could boost consumer demand, especially in retail. From this perspective, we think Chilean shopping malls offer an interesting investment opportunity. A recovery in Chile’s retail sales during 2024 could act as a tailwind for this industry and we believe this could be a good entry point for investors as the monetary easing cycle is still in its initial phase. We particularly like Parque Arauco, a real estate company which operates shopping malls. Parque Arauco is focused primarily on Peru and Colombia in the Andean region, a high-growth area when looking at the shopping malls segment in LATAM. It also has the cheapest valuation in the industry and could benefit from its new multifamily property portfolio.
Argentina: Economic Reforms Show Promise
Argentina is undergoing a transformative period under President Milei’s administration. The government has acted swiftly to address deep-seated economic distortions by cutting federal aid, devaluing the peso, eliminating subsidies, and reducing fiscal and monetary imbalances.
The Argentine government is also pushing for comprehensive structural reforms in the labor, tax, and energy sectors. The approval of the Omnibus bill that includes clauses on privatization, investment incentives, delegation of powers, labor reform and tax changes could improve investor sentiment and help the country secure a new IMF development loan. Argentina’s Lower House approved the bill at the end of April. The bill is now up for a vote in the Senate and a potential approval could lift Argentinian equities.
The government’s policies have already started to yield results, with the fiscal deficit reduced to 0% and inflation dropping from above 20% per month to single digits in April 2024.
Headline CPI
Source: INDEC and J.P. Morgan as of 1/31/2024.
Structural Reforms and Sector Opportunities
We believe the banking sector could be an interesting investment opportunity. The sector’s low levels of penetration and concentration present opportunities for consolidation and expansion. As inflation stabilizes, lower interest rates are expected to stimulate loan demand, starting with corporate lending and eventually extending to consumer and mortgage lending.
Most Argentineans are educated and almost 40% of the population is considered middle class. The money generated by the Argentineans has been consistently exported or hidden as dollars as a defensive measure to preserve value. The estimated savings held outside the banking system is above $200bn.4 This amount is many times the size of local banks and placing at least some of that money back to work in Argentina could have a significant multiplier effect on credit.
With more than 70 banks in the market but only 10 managing 70% of the market, there is substantial room for growth and consolidation in the industry. We think banks like Grupo Galicia and Banco Macro are well-positioned to capitalize on these opportunities.
Historically, Argentinean banks have had a purely transactional role and have operated on a small scale. The banking sector could take off if the government succeeds in containing inflation. Argentinean corporates and consumers have low levels of debt leverage and there is room for credit growth. The banking sector could also benefit if the savings rate increases as real rates go up.
Scouting Investment Opportunities
Chile’s growth momentum, driven by a strong commodity outlook, along with Argentina’s bold economic reforms, may begin to offer compelling investment opportunities. While we do not have exposure to these markets yet, we believe there are pockets of structural growth opportunities in these two countries. Staying attuned to ongoing reforms and market developments will be key to successfully navigating these dynamic markets.
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Originally published 5 June 2024.
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IMPORTANT DISCLOSURES
1 Chile’s Government Sets Pension Reform Bill on Fast Track.
2 Chile’s economic activity posts largest increase since mid-2022.
3 JPM Research.
4 VanEck Research.
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Controlling inflation remains the cornerstone of Argentina’s economic revival. The goal is to bring inflation down to 4-5% per month by year-end. Achieving this target would be a significant milestone, instilling confidence among local and international investors and potentially leading to a multi-year period of capital inflows and expanded market activity.
