Could commodities price inflation derail Asian equity markets? UBS

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4) Could commodities price inflation derail
Asian equity markets?
A major beneficiary from prospects of QE2 and a weakening US dollar has been
commodity prices. The Commodity Research Bureau All Commodities spot
index has already exceeded its previous peak in 2008 (Chart 7). Could
commodities price inflation pose a threat to Asian equities?
We think this could be a serious risk down the road if higher commodity prices
feed through to accelerating inflation in the region. This would force central
banks to tighten, which is at the margin negative to equities. It could become a
major headwind if the central bank is seen as ‘behind the curve’ and would need
to sharply slow down the economy to rein in inflation.
At the moment, the risk seems manageable. The single most important
commodity that affects inflation in Asia is oil. It is the biggest contributor to the
CPI basket, especially in poorer Asian countries, directly via energy cost and
indirectly via food prices. The oil price has been relatively subdued because of
weak demand in developed countries, the largest consumers of the commodity.



What happened to equities when commodity prices spiked?
When commodity prices went parabolic during the first half of 2008, Asian
equities fell. However, the weak equity market performance was more likely the
result of growth concerns about the economy, even though the commodity price
moves were unhelpful.
We also note that equity market performance was strong during 2003-07, when
the CRB index rose by 69% and the oil price trebled. It seems to us that growth
expectations would trump the commodities cost concerns.
Still, could volatility in commodity prices affect short-term equity market
performance? Also, given that different Asian countries have varying levels of
exposure to commodities, could this lead to a divergence in relative
performance?


We analyse the short-term performance of various Asian markets during spikes
in crude oil prices (Table 4). There does not seem to be a conclusive pattern. At
the country level, whilst there are some instances of underperformance for
countries that are more affected by the oil price (India, Indonesia), the evidence
is again not conclusive.


Should we ignore commodities?
Does that mean commodity prices are irrelevant to Asia ex Japan equities? We
think at the margin commodities do have an impact on equities, but other factors
such as the macroeconomic outlook and monetary policies probably take
precedence.
Where we do think commodities could pose a more serious risk in the near-term
is in countries where there are already rising inflation risks, and volatility in
commodity prices could force the hand of the central banks to tighten.
Indonesia could be a candidate. India has also seen its inflation rise this year,
but Philip Wyatt, our economist, believes that the pressure will likely fade going
into 2011 with normal monsoon and favourable base effect.