LP L FINANCIAL R E S E AR C H

Weekly Market Commentary

July 28, 2008
v4

Asian Contagion Part II?

A pullback in the outlook for inflation would likely propel a powerful stock
Jeffrey Kleintop, CFA
market rally in the U.S. With the primary driver of overall inflation stemming
Chief Market Strategist
LPL Financial from global food and energy commodity price pressures, the key to falling
inflation may be a slower pace of emerging market growth. This slowdown
appears to be unfolding.
Highlights
China has been an engine of growth for a long time. However, the Chinese
China’s pace of economic growth has started to economy faces many challenges in the quarters ahead that may lead to a
slow, and other emerging market countries are slowdown in growth:
also seeing signs of slowdown.
ƒ The Chinese government is increasingly allowing higher food and energy
In the aftermath of the 1997-1998 emerging prices to pass through to consumers.
market led slowdown, oil prices fell by 60%
ƒ China’s central bankers have slowed the pace of lending by hiking the
to about $10 per barrel and other non-energy
reserve requirement ratio an unprecedented magnitude from 7.2 to 17.5
commodities experienced similarly large
over the past two years and raising the base lending rate (the Chinese
declines. While we are not predicting the
version of the Federal Funds rate) by nearly 200 basis points.
Asian Contagion part II, as the global growth
engines shift into a lower gear, commodity ƒ The China Shanghai Composite Stock Index has plunged 53% since
prices may continue to slide. peaking in October and is following the early 2000s path of the NASDAQ
Composite stock index – the NASDAQ Composite bubble burst
With the primary driver of overall inflation preceded a recession in the U.S. [chart 1]
stemming from global food and energy
ƒ The start of an Olympic-size hangover may be underway from the
commodity price pressures, the key to falling
inflation may be a slower pace of emerging
slowdown in all the preparatory infrastructure spending combined with
market growth. If global commodities prices
the fact that nearly every country that has hosted the Olympics has
continue to come down and ease inflation
experienced a slowdown in economic growth in the following year.
pressures in the U.S., the stock market could
CHINA HEADED FOR OLYMPIC-SIZE HANGOVER IN 2009?
post a powerful rally.
Change in GDP Growth Rate
Olympic Year Country in Following Year
1 Shanghai Composite Mirroring NASDAQ 1964 Japan -5.9%
Composite of Seven Years Ago 1968 Mexico -6.0%
NASDAQ Composite from March 1997 to March 2003 1972 Germany +0.5%
Shanghai Composite from July 2004 to present
7000
1976 Canada -1.7%
6000
1980 Russia +0.9%
1984 U.S. -1.4%
5000
1988 Korea -5.3%
4000
1992 Spain -2.0%
3000
1996 U.S. -0.1%
2000 2000 Australia -1.3%
1000 2004 Greece -1.0%
0 2008 China ?
July July July July July July July
2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg, LPL Financial

Source: Bloomberg, LPL Financial

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 W E E KLY MARKE T COMME N TAR Y

Indeed, China’s GDP growth has started to slow, posting second quarter
GDP of 10.2%, down 2.4% from 12.6% a year ago, and the index of leading
indicators, from the Chinese National Bureau of Statistics and Goldman
Sachs, reflects a slowing trend. Other so-called, BRIC (Brazil, Russia, India,
and China) countries are also seeing signs of slowdown—Brazil and India
have seen sharp downturns in their leading indicators of economic growth.
One of the countries that has been hit the hardest is Vietnam; the country’s
Ho Chi Minh stock index fell last week by the largest amount in four months
and has declined by -63% from the peak with inflation rising at a 27% pace
over the past year, pressuring five year government bonds to yield 20%.
In recent months, many emerging market nations are hiking interest rates
and passing on higher energy prices:
ƒ Rate hikes have been implemented in Brazil, Chile, Indonesia,
Philippines, South Africa, and Vietnam.
ƒ China has raised gasoline prices 17% and diesel by 18%.
ƒ India raised fuel prices by 13%.
ƒ South Korea announced an increase of 50% to natural gas prices.
ƒ Malaysia announced a 40% increase in gas prices.
ƒ Thailand raised gasoline prices by 41%.
ƒ Taiwan raised gasoline and electricity prices by 13%.
ƒ Indonesia raised fuel prices by 29%.
ƒ Nepal raised fuel prices by 25%.
ƒ Bhutan announced roughly 10% hike in gasoline prices.
ƒ Sri Lanka raised prices on gasoline, diesel and kerosene by 14–47%.
The last time Southeast Asian economies were under this much stress
was in August of 1997, when fleeing capital triggered a cascade of financial
collapse among emerging nations. Within days of Thailand’s collapse, many
of its neighbors were brought down, and within months financial crashes
were seen in Japan and South Korea and reached as far as Russia and Brazil.
In the aftermath of 1997–1998 emerging market led slowdown, oil prices
fell by 60% to about $10 per barrel and other non-energy commodities
experienced similarly large declines. While we are not predicting the Asian
Contagion part II, as the global growth engines shift into a lower gear
commodity prices may continue to slide.

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 W E E KLY MARKE T COMME N TAR Y

EMERGING MARKET COUNTRIES PASSING HIGHER PRICES ON TO CONSUMERS

Commodity Price Change from Recent Peak
Corn -13.0%
Soybeans -15.0%
Wheat -34.9%
Rice -25.5%
Crude Oil -15.2%
Nat Gas -33.1%
Gold -7.3%
Silver -14.8%
Aluminum -10.8%
Copper -11.3%
Nickel -55.6%
Source: Bloomberg, LPL Financial
In the U.S., inflation pressure is largely contained within commodities. If
global commodities prices continue to come down and ease inflation
pressures in the U.S., the stock market could post a powerful rally. On
the other hand, many emerging market countries are experiencing a huge
surge in inflation, which has become embedded in wage growth and may
make inflation pressures slower to dissipate as commodity prices fall.
The potential combination of slowing growth and stubborn inflation in the
emerging markets leaves us negative on the prospects for emerging market
stock performance and in favor of developed markets, especially the U.S.

IMPORTANT DISCLOSURES
This report has been prepared by LPL Financial from sources believed to be reliable but no guarantee can be
made as to its accuracy or completeness. The opinions expressed herein are for general information only, are
subject to change without notice, and are not intended to provide specific advice or recommendations for any
individuals. Please contact your advisor with any questions regarding this report.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and
political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially
less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
Indices are unmanaged and cannot be invested into directly.

This research material has been prepared by LPL Financial.

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