Position for a high oil price
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Almost three months into 2012, Asian stocks, our favourite asset class, have performed quite impressively.
The MSCI Asia Pacific ex Japan Index, the broad measure of Asian stock markets, has risen 12.5 per cent, outperforming the MSCI World Index, which gained 11 per cent. The Hang Seng China Enterprise Index (H-Shares) is the top performer among Asian markets with 19-per-cent gain, while the SET Index lagged the Asian benchmark with 13-per-cent gain. Given attractive valuations and strong growth prospect, we believe Asian stocks will continue to do well this year. However, the rising oil price is becoming a major concern in the stock market.
Tension in Iran has put world economic recovery at risk. The price of Brent crude oil has risen 15 per cent this year to $125 a barrel, a level last seen during the peak of the Libyan civil war in April 2011. In the crude-oil market, Iran is much more important than Libya. It is the fifth largest oil producer in the world, pumping 4.2 million barrels per day, or 5 per cent of global oil supply. More importantly, the Strait of Hormuz between Iran and Oman is the world’s most important oil transportation channel, carrying 20 per cent of world crude oil supply. A war in Iran could shut off the strait and trigger a dramatic spike in the oil price, which would imperil the tepid economic recovery in the US and Europe and add inflationary pressure in the emerging markets.
Iran’s nuclear ambition is a major threat to political stability in the Middle East. It is especially worrying to Israel, which has a long history of conflict with the country. With Tehran resisting international efforts to thwart its nuclear programme, an Israeli strike on Iran’s nuclear facilities remains a possibility.
Investors should be aware of the risk and manage their portfolio accordingly. We recommend investors to take following steps to adjust their portfolio:
_ Take profit in Thai stocks. The Thai economy is the most vulnerable to a rising oil price. Thailand’s net import of oil as a percentage of GDP is the highest in Asia. An IMF study showed a negative impact on Thai GDP growth of 1.8 percentage points for a sustained rise of $10/barrel in oil price – much higher than the average impact on Asian GDP growth of 0.8 percentage points. Moreover, due to the fact that the Thai market has outperformed its Asian peers in the past three years, Thai stocks are now relatively expensive. The SET index is trading 12 times price-to-earnings, higher than the MSCI Asia Pacific ex Japan Index, which is trading at 11.3 times.
_ Investors may want to switch holding of Thai stocks to other Asian countries where valuations are cheaper and the impact of the oil price is much more limited. China, for example, is in a much better position. As the world’s fourth largest crude oil producer, China produces more than half of the oil it consumes. The China H-Shares Index is also trading at a very cheap price-to-earnings of 8.3 times.
_ Diversify into commodities. Holding commodities like oil and gold in your investment portfolio could reduce risk substantially. Oil provides a direct hedge against an oil price spike that could hurt other investment assets. Gold, on the other hand, usually performs well during time of war. The recent 5-per-cent drop in gold provides attractive buying opportunity for investors.
Komsorn Prakobphol is wealth manager at Tisco Asset Management. He can be reached via www.TiscoWealth.com.
