The three scenarios the market is weighing for this weekend

The past 19 months have been marked by strong political polarization, most notably the confrontation between the executive and legislative branches. For financial markets, this has increased political risk in Chile and dampened the tailwind produced by the successful vaccination plan and the good outlook for copper.

However, it's important to note that all of this has been done without clearly knowing the electorate's opinion. This is the main reason this weekend's election is so decisive for the market. We will finally understand whether or not there is a structural change in the country, with the consequences that could bring.

Essentially, we believe there are three scenarios the market is weighing; obviously these are an abstraction, since there are a great many variables and nuances that would be hard to isolate, and the final outcome will probably be a combination of some of them.

Base scenario:

In the base scenario, the Vamos por Chile list (the current governing coalition) obtains a low vote share relative to previous elections but keeps the one-third of delegates needed to exercise a veto. Within the opposition, the Lista del Apruebo (former Concertación) wins the most votes, and its balance with the Apruebo Dignidad list (Communist Party + Frente Amplio) is similar to historical levels. In this scenario, the coordination within the convention becomes particularly relevant.

In this context, the local stock market could rise about 3%, mainly because the risk of a negative scenario is removed, while the exchange rate could fall around 1.5% from its current level.

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Negative scenario for the markets

The governing coalition obtains less than a third of the delegates, losing its veto, and the Apruebo Dignidad pact obtains a share within the convention far above what this more radical left-wing sector has traditionally obtained.

In this scenario, not only would uncertainty arise over the drafting of the new Constitution, but it is also likely that pressure would increase to generate more populist-leaning policies in Congress, with the consequent degradation of public policy.

It is obviously very difficult to make projections about market behavior, but given what has happened in other events that could be considered similar (reactions to electoral surprises implying structural changes in the political regime), it would be reasonable for local stocks to fall around 20% and the peso to depreciate around 10%. This scenario would also be accompanied by strong volatility in rates.

Positive scenario for the markets:

In a positive scenario for the markets, the hypothesis that Chile changed structurally is firmly rejected. The Vamos por Chile list obtains a vote share above what it got in the last parliamentary election, and within the opposition the Lista del Apruebo obtains a considerably higher vote than Apruebo Dignidad. Additionally, within the Lista del Apruebo, candidates closer to the political center are elected. This cools down the legislative agenda and the perception of political risk in Chile decreases considerably.

This could go hand in hand with an appreciation of the peso of around 6% and a rise in the local stock market of 12%.

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As for the probabilities of each scenario, we estimate the negative scenario has a 15% chance of occurring, the good one 10% and the base one 75%. The calculation of implied probabilities derives from the estimated declines or gains for the two most extreme scenarios.

It is important to note that this analysis has no political color; rather, it derives from similar events. That said, prices are dynamic and react quickly to new information.

This column was originally published in El Mercurio Inversiones [LINK] on 14–04–2021