The epic proportion of fiscal stimulus in advanced economies, pent-up demand post COVID and supply-chain shortages had together raised inflation in the global economy since 2021. As the pandemic subsided in 2022, the expectation of many had been for raw material shortages to ebb and inflation worries to gradually subside.
Enter Russia’s invasion of Ukraine and its grave implication on the commodity market. Russia is an important exporter of crude oil, natural gas, aluminium, palladium and wheat among other commodities. As Western governments slap sanctions against Russia, commodity prices including Brent Crude have rallied. Higher commodity prices are likely to elevate inflation, particularly in net oil and commodity importing nations.
ASEAN stocks thrive during inflation:
Investors can prepare themselves for the equity-market volatility by investing in stocks and sectors that benefit from higher inflation. In an earlier post, I had identified sectors such as banks, insurance, energy and real estate, where companies see higher revenue during inflationary periods.
One way to play the inflation theme is by investing in ASEAN equities. If we take a look at the MSCI ASEAN index — financials constitute 38% of the index, followed by consumer staples at 8.31%, real estate at 8.19%, materials at 6.04% and energy at 4.49%. Over 60% of the index contains stocks that thrive during inflation!
How certain sectors react to inflation:
- Financial stocks thrive during rising inflation as central banks hike their policy rate to manage price pressures. This increase in the policy rate allows banks to charge higher interest on their loans.
- Consumer staples are products that are essential for daily living such as food, clothing and personal products. Rising prices drive consumers to cut back on discretionary spending (on new gadgets, vehicles) and concentrate spending on essential items.
- Real estate benefits from higher rent and property investment to hedge against falling purchasing power of currency.
- The materials’ sector comprises companies producing chemicals, construction materials, containers and packaging goods and metals and mining products. You may have been reading about the rally in gold, silver, aluminium and copper among other metals since 2021, given the economic reopening, surge in demand and constrained supply in these items.
MSCI ASEAN constitutes countries rated investment grade:
By country, the MSCI ASEAN index is dominated by Singapore, a AAA rated credit (highest credit rating) by S&P, Moody’s and Fitch ratings. Thailand, Indonesia, Malaysia and Philippines, the other countries in the index, are all rated investment grade by the agencies. While ASEAN countries are mostly classified as emerging markets, consider them to be better quality EMs given their historical growth profile, government indebtedness, central bank policymaking and business environment.
The top 10 constituents of the index are all large cap stocks (where market capitalization exceeds USD 10 billion), indicating that the index benefits from quality companies that offer stability during periods of geopolitical unrest and risk-off.
ASEAN’s macro outlook is likely to improve in 2022:
Barring Singapore which profited from 7.6% y/y growth in 2021, all other ASEAN economies underperformed growth expectation set at the start of last year. This was led by the spread of the highly infectious Delta variant, low vaccination rates and intermittent imposition of movement restrictions in these nations. This suggests the scope for strong recovery in 2022, led by better vaccine coverage, milder impact of the Omicron variant and with pent-up demand being unleashed.
As per the IMF, the average growth rate of Thailand, Indonesia, Malaysia and Philippines is forecasted at 5.67% y/y in 2022 compared to 2.72% in 2021. This improvement in growth, led by consumer spending and business revival is likely to support companies and stocks. Consumer price inflation is also forecasted to maintain steadiness at 2.29% in 2022 compared to 2.3% in 2021, much higher than the 0.67% seen in 2020. Higher inflation will support the MSCI ASEAN index.
Good growth outlook, attracts foreign capital. The capital flow tracker prepared by the Institute of International Finance (IIF) corroborates this statement for the ASEAN region. The graph below shows foreign capital returning to EM ASEAN countries in late 2021.
Conclusion:
- Inflation pressures are likely to persist in 2022 given geopolitical developments and economic recovery.
- Investors should modify their portfolio by adding stocks that benefit from higher inflation.
- One solution is by investing in the MSCI ASEAN index. Over 70% of the index is composed of sectors that thrive during inflation.
- MSCI ASEAN’s country exposure is dominated by Singapore, a country rated AAA by the rating agencies. The index is exposed to quality large cap names that are likely to protect the portfolio from equity market volatility.
