Chile, Facing Challenges, Sees Stocks Stall in the Second Quarter
Don Dion
Don's Investment Newsletter: Don's Asset Management Business:
Until a few months ago Chile’s Santiago Stock Exchange—like many of its Latin American neighbors’—was doing well, thanks in part to the commodity price boom, fueled by insatiable demand from the developing world.
The iShares MSCI Chile ETF (ECH) gained nearly 9% in the first quarter, while the S&P 500 fell 10%. 
ECH hit an all-time high on April 23, but has fallen 17.9% since, including a 12% drop in the three months ended Aug. 29. Over the latter period, the S&P 500 fell just 8%.
That’s not the kind of returns investors here have come to expect. Over the five years prior to the fund’s high, Latin American funds averaged a 44% annualized gain.
Still, ECH has held up better than most. The ETF is off just 7.3% this year, which beats the MSCI EAFE Index (EFA) by more than 11%. The ETF’s three-month performance ranks in the top 1% of Latin American funds and beats the MSCI EAFE Index by more than two percentage points. ECH also outperformed iShares’ MSCI Emerging Markets (EEM) (down 20.6%), Brazil (EWZ) (down 26.1%) and Latin America 40 (ILF) (down 21.9%) for that period. We added ECH to the ETF Momentum Tracker portfolio last week.
As Latin American funds became world-beaters in recent years, ECH was promoted as an indirect play on growth in China and India—thanks to its natural resources—and for having a market that is less risky than it used to be, backed by a growing domestic economy. That, bulls say, may still be the case—at least in the long term.
Like other South American nations, Chile is rich in natural resources, including fish, forestry products and metals. But copper helped fuel the market’s rise more than anything else. The nation produces about one-third of the world’s copper, and the metal makes up more than half of its exports. Copper prices surged to a record high in the first half of the year but fell recently, and while ECH’s holdings don’t appear to be reliant on copper mining, a significant drop in copper prices tends to hinder growth and dampen investors’ enthusiasm about Chile.
Chile has other issues too. First off is inflation, which recently soared to a 9.5% annualized rate, the highest level since 1994. Chile’s economy has also been stung by an ongoing energy shortage. A shortage of natural gas has forced power companies to use more expensive fuels, and a drought cut into hydro-electric production. Soaring power prices could also endanger economic growth, especially with demand on the rise.
But ECH also has some things going for it. Unlike some of its neighbors, Chile wasn’t overly exposed to the U.S. financials sector or heavily reliant on the U.S. as a trading partner, two reasons ECH has held up better than other Latin American funds.
The country’s economy grew 4.3% in the second quarter, up from 3.3% in the first quarter. The expansion was largely due to an 11% increase in domestic demand.
That growth gave the country’s central bank room to raise interest rates—up 1.25% this year, to a nine-year high of 7.75%, with another increase expected this week—in an effort to stave off inflation. Furthermore, the government has implemented several initiatives designed to prevent the rapidly appreciating peso from overheating—most notably an $8 billion intervention program that was introduced last April and a more recent cut in taxes on fuels and some banking services. These steps seem to be working, as the currency has sharply depreciated in recent months.
The energy shortage, meanwhile, may be good news for two of the fund’s top four holdings, No. 2 Empresa Nacional de Electricidad (EOC) (The National Electric Company of Chile) and another electricity company, No. 3 holding Enersis (ENI). Both firms generate fairly low-cost electricity and appear positioned to produce enough power in the coming years to take advantage of high prices. Enersis shares are up nearly 14% since July 8 (and 7% year to date), while Empresa Nacional de Electricidad stock has gained 21.1% year to date.
The fund might be doing even better if not for the fortunes of top holding Empresas Copec, which has seen share prices slide 24.3% in the last year. Investors may take heart from a recent analyst poll projecting a 12-month target price that would represent a 31.8% gain.
Some of ECH’s top holdings have been sensitive to a slight slowdown in global agriculture and pulp and paper markets, which were robust during the first half of the year. Shares in No. 4 holding Sociedad Química y Minera de Chile (SQM), a producer of fertilizer, fell more than 6% in August after gaining an impressive 144% in the year ending Aug. 29.
The bottom line: ECH hasn’t been able to post the kind of otherworldly returns some came to expect, but it’s done better than its peers, making it an attractive niche play for direct exposure to Latin America and an indirect link to China.
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This article has 1 comment:
- David Lentz
- 353 Comments
Sep 04 01:27 PMWhile fertilizer sales are headed lower -- temporarily, people still need to eat, and the last time I checked, they were still making people at a ridiculous rate -- this is a temporary situation that is probably best treated as an opportunity to accumulate more SQM. Hopefully, the managers of ECH will be loading up on SQM at depressed levels.
Food never goes out of favor for long, and it takes fertilizer to make food.
disclosure: yes (isn't it obvious?), I own SQM.
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