Tài liệu Bản báo cáo của HSBC quý 2 năm 2008 (tiếng Anh) pdf

Country weights and key reasons for our view recommended weight Last Quarter Rel perf last 3 mths Japan 49.0% 44.0% UNDER UNDER 6.3% Valuation the cheapest in history Economy alread

By Garry Evans

What kind of bear?

Asia’s bear market is likely to be mild, not vicious

The investment world has changed We believe that Asia is now in a bear market.From last October’s peak, the index has fallen 29% Risk aversion is likely to continue

and US growth will slow over the coming months

It may not be a particularly nasty bear, though We see a “W-shaped” slowdown inthe US, not a recession Asian economic growth will decouple to a degree There

could even be a bounce in the second half as US policy initiatives kick in

But investment style in a bear market needs to be very different to what worked in2003-7 Investors can either aggressively trade the dips and rallies, or stick to quality,

long-term growth, which may become available cheaply

We recommend China, which represents good value again, Thailand and Korea forpolitical change, and Malaysia which is classically defensive and where politicalworries are overdone For sectors, we stick to structural growth stories such asconsumer-related names, telecoms, infrastructure (for example, steel) and

healthcare Avoid Taiwan, Japan, technology, financials and energy

Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Steven Y Sun, CFA*

Strategist +852 2822 4298 stevensun@hsbc.com.hk Steven Y Sun is a strategist on HSBC’s Asia-Pacific equity strategy team Steven joined HSBC in 2006, prior to which he was a China specialist for a private macroeconomic consultancy in Washington DC Steven began his career as a financial analyst for a state-owned financial institution in Beijing in 1996.

Akane Nishizaki*

Strategist +813 5203 3943 akane.nishizak@hsbc.co.jp Akane joined HSBC as a graduate trainee in 2001 After training, she worked in the treasury department in Tokyo for more than a year, selling foreign exchange, mainly options She joined the equity research department in April 2005 as an associate

in strategy.

Jacqueline Tse*

Strategist +852 2822 6602 jacquelinetse@hsbc.com.hk Jacqueline joined HSBC in February 2008 as an Equity Strategist, Asia Pacific Her previous experience includes working with the corporate treasury team of a leading investment bank with particular emphasis on Korea, Thailand and Malaysia, Associate Economist for a leading bank, and Senior Financial Analyst for Hewlett Packard She holds an MSc in Management Science and Operations Research from Columbia University, and a BA in Economics from the University of California, Berkeley.

Strategist +852 2996 6916 garryevans@hsbc.com.hk Garry heads HSBC’s equity strategy team in Asia-Pacific His previous roles at HSBC include Head of Pan-Asian Equity

Research and Chief Japan Strategist Garry began his career as a financial journalist and was editor of Euromoney magazine

for eight years before joining HSBC in Tokyo in 1998.

Leo Li*

Strategy Associate +852 2996 6919 leofli@hsbc.com.hk Leo Li joined HSBC as a strategy associate in 2007 He started his career in the finance industry as a marketing executive in RNC Capital after graduating from UC Irvine with an MBA in 2004 Leo also has a Bachelors degree in Information Engineering from the Chinese University of Hong Kong.

Vivek R Misra*

Associate Bangalore

Devendra Joshi*

Associate Bangalore

*Employed by non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to NYSE and/or NASD regulations.

Country weights and key reasons for our view

recommended weight

Last Quarter

Rel perf last

3 mths

Japan 49.0% 44.0% UNDER UNDER 6.3% Valuation the cheapest in history Economy already in recession

Earnings growth likely to turn negative Politics in a stalemate

Australia 12.3% 11.0% UNDER NEUTRAL -0.4% Domestic institutional buying should be a support Central bank still in tightening mode

May not prove as defensive as in the past China 8.3% 10.0% OVER OVER -17.2% Valuations reasonable again, with PE down to 13x

Economy likely to continue to grow robustly this year Long-term growth story intact

Investor sentiment badly dented

Korea 8.0% 9.5% OVER OVER -10.2% Lee Myung-bak’s policy programme a big positive

Cheapest market in Asia, on PE of 10x

Facing strong cyclical headwinds Taiwan 6.6% 5.5% UNDER UNDER 16.1% New president will improve relations with Beijing… …but perhaps not as fast as market expects

The most cyclical market in Asia The two key sectors, banks and IT, both unattractive

HK 5.0% 5.0% NEUTRAL NEUTRAL -10.0% Negative real interest rates GDP and earnings growth set to slow this year

Prospects for property market are mixed India 4.1% 4.5% NEUTRAL OVER -18.4% Low sensitivity to exports and US economy

Long-term structural growth story still exciting

Downside risk to consensus earnings forecast GDP growth to slow to 7% in FY2008-9 Election in H2 will make market nervous Singapore 2.3% 4.0% OVER OVER 1.8% Liquidity conditions to remain loose

Cheap, with PE down to 12x Defensive, with range of blue-chip growth companies

Exports are very high percentage of GDP

Malaysia 1.5% 2.5% OVER UNDER 1.5% Political worries after March’s election are overstated

Valuations now reasonable

Political concerns may linger if PM resigns Economy – but not listed stocks – rather cyclical Thailand 1.0% 2.5% OVER OVER 19.8% New government to boost infrastructure spending

Cheap: PE 11x

Political instability not over Indonesia 1.0% 0.5% UNDER UNDER 3.1% Economic growth to be robust ahead of 2009 election Structural worries: inflation and budget deficit

Not cheap for such as volatile market

Vietnam 0.0% 1.0% OFF-BMK OFF-BMK -20.8% Offers long-term value for an exciting story Government has grossly mishandled macro policy

Source: HSBC, Note: In this and other tables, markets or sectors are ranked by their neutral weight in the MSCI Asia-Pacific index

Sector weights and key reasons for our view

recommended weight

Last Quarter *

Rel perf last

3 mnths

Financials 24.5% 22.0% UNDER NEUTRAL -6.7% Long-term asset-gatherer story still intact NPLs likely to rise as economies slow

Falling interest rates will hurt net margins Industrials 15.8% 13.5% UNDER UNDER 2.0% Infrastructure-related companies attractive Sector contains many cyclical stocks

IT 12.9% 11.0% UNDER UNDER 2.6% LCD panels to do well until Olympics Company guidance weakening sharply

High raw materials prices squeezing margins Earnings forecasts to be revised down further Cons Discretionary 12.7% 10.5% UNDER UNDER 2.0% Structural consumer story in Asia intact Many stocks very export oriented

Auto makers dependent on US consumer Materials 11.7% 12.0% NEUTRAL UNDER 2.7% Asian steel demand remains strong Commodity prices likely to be only mixed

Telecoms 5.8% 8.5% OVER OVER -0.1% Non-cyclical growth story continues

Valuations back to reasonable levels

Regulatory risk Energy 4.6% 4.5% NEUTRAL OVER -5.7% Refining margins likely to improve further Oil stocks decoupled from crude price

Regulatory risk as governments keep prices down Cons Staples 4.2% 7.5% OVER OVER 6.2% One of the most defensive sectors

Beneficiary of the Asian consumer story

Valuations quite expensive Utilities 4.2% 4.5% NEUTRAL OVER 10.5% Most defensive sector High input costs raise regulatory risk

Health Care 3.5% 6.0% OVER OVER 8.0% Defensive, with strong structural growth Few large-cap stocks

Source: HSBC (*Note that last quarter, cons discretionary, materials and industrials were bundled together under cyclicals (UNDER), and consumer staples, healthcare and utilities under defensives (OVER))

A bear market

…but what kind?

If it looks like a bear market and feels like a bear market, it probably is a bear market At its low point in

March, MSCI Asia ex Japan was down 29.6% from its peak last October In our view, that puts it

technically in bear market territory And fundamentals over the next few months will point to the same

conclusion: we expect one quarter of negative growth for the US in the first half, risk aversion to continue

as credit markets remain dysfunctional for some time yet, international investors – who sold USD39bn of

Asian equities in the past three months – to remain risk-averse, and inflation (now averaging over 6% in

Asia ex Japan) to handicap some Asian central banks from cutting rates aggressively

But bear markets need not be that vicious From among the three bear markets in Asian investment

history, 1994 stands out as being relatively mild, with stocks bumping along the bottom for a year or so

but without the stomach-churning drops seen in 1997-8 or 2000-1 We believe the chances are fairly high

that 2007-8 will be a mild bear market too: the US will see growth slow to 1.5% this year but will (just)

escape a technical recession, the US authorities have reacted quickly to tackle financial risks, Asian

economic growth is likely to decouple to a degree from the US slowdown, and so far at least analysts’

Summary

There are more uncertainties about the short-term outlook for Asian

equities than usual How long will risk aversion continue? How

much will the US slow, and for how long? Will Asian earnings

forecasts be cut? But there is little doubt that markets will continue

to be tricky for some time Even though the exact trajectory of the

next nine months is hard to predict (for what it is worth, we expect

another leg down followed by a second half rebound and a

disappointing 2009), any outcome points to investors needing to be

prudent and sticking to quality, structural growth stories at

reasonable valuations

Key changes in view

Lower Australia UNDER NEUTRAL Economy slowing while central bank raising rates; commodity outlook mixed

Lower India NEUTRAL OVER Nervousness about H2 election; earnings forecasts may be revised down

Raise Malaysia OVER UNDER Valuations now reasonable; post-election politics not so big a risk

Lower Financials UNDER NEUTRAL Falling net margins, rising NPLs, futher US-related write-offs

Lower Energy NEUTRAL OVER Regulatory risk: governments keeping retail energy prices down

Source: HSBC

forecasts for Asian earnings growth have hardly been revised down at all – suggesting we may avoid an

earnings recession

The exact trajectory of Asian stock markets for the next six months is hard to forecast because there are

so many uncertainties Based on our US economists’ view of a “W-shaped” slowdown in the US, the

most likely scenario in our view is one where credit problems over the next quarter cause a further leg

down for Asian stocks, followed by a rebound in the second half, as the US economy responds to tax and

rate cuts, but then a period of disappointment in 2009 as global growth remains sluggish and credit

conditions stay tight For this reason, we forecast just a 1% rise in MSCI Asia Pacific to year-end, but a

slightly better 10% rise for the higher beta MSCI Asia ex Japan

Whatever the exact trajectory, it is clear we are in a different investment world to the gung-ho bull market

of 2003-7 It is harder, but not impossible, for investors to make profits in such a market Whatever type

of bear market this turns out to be, though, the investment strategy should be the same We see only two

ways of playing this sort of market: (1) to trade in and out of the dips and rallies (since bear markets tend

to be characterised by sharp, 10%-plus, rallies as investors try to spot the bottom); (2) to focus on quality,

long-term structural growth stories (the Asian consumer, infrastructure, improving technology, healthcare

etc), where stocks will fall enough to become available from time to time at attractive valuations

Market calls

Transparent, stable, liquid, cheap – and changing

In this sort of market, ideally we want to be invested in markets with (1) good earnings visibility, (2) low

sensitivity to US growth, (3) loose monetary policy and strong liquidity, (3) attractive valuations, (4) low

risk of structural problems, and (5) ideally, a non-correlated reason to outperform, such as political

change Obviously, no single market will have all these factors, but our country recommendations are

based on those that have a good smattering of them (see our scorecard on p17)

We continue to overweight China: PE has almost halved to 13x, earnings momentum remains positive

and this year’s forecast of 21% growth should be comfortably achievable, and the risk of inflation

accelerating is overdone We like two markets where political change will help: Thailand and Korea

(coincidentally, also the two cheapest markets in the region) In Thailand, the new democratically elected

Index targets

3/27/2008

Target end 2008

end-2008 target

Target end 2009

Source: HSBC

government should survive longer than some people fear, and will spend to kick-start growth Korea is a

little cyclical for the current circumstances (so we recommend domestic plays, not exporters), but the

policies of new president Lee Myung-bak look interesting and could be implemented quickly if he wins a

parliamentary majority on 9 April We have moved to overweight on Malaysia, where the earlier

premium valuation has disappeared and where worries about political turmoil after the recent election are,

in our view, exaggerated This is Asia’s most defensive market, and can now be bought on a reasonable

multiple We stay overweight Singapore, which also offers an attractive combination of strong liquidity,

low risk and PE well below the historic average

Perhaps our most non-consensus underweight is Taiwan, which almost every investor has got

enthusiastic about after the KMT’s victory in the parliamentary election and Ma Ying-jeou’s election as

president We fear that cross-straits negotiations may not progress as fast as many expect Moreover,

Taiwan is the most cyclical market in Asia and its two main sectors, banks and technology (72% of

market cap), are unattractive, although we do like retailers, construction, and chemical stocks We stay

underweight Japan: the economy is probably already in recession, and earnings are likely to fall this

fiscal year because of the strong yen We have lowered Australia to underweight from neutral: it may not

prove as defensive this time as traditionally since it is very dependent on commodities, has a high

weighting of banks in the index, and a very hawkish central bank We stay underweight the two riskiest

Asean markets, Indonesia and Philippines, both of which could have emergent inflation problems We

have lowered India to neutral, since valuations have not yet derated as much as the rest of the region,

earnings forecasts (currently 20%) are likely to be revised down, and the election in H2 will cause jitters

Sector calls

Stick to quality blue-chips

We want to stick mainly to quality blue-chip names in the twin Asia structural growth themes of (1)

consumption and (2) infrastructure Many of these names sold off heavily in Q1, partly because they were

heavily owned by foreigners, and partly because they had simply got too expensive in late 2007 Sectors

such as Chinese telecoms or retailers underperformed hugely in Q1, which has brought valuations down

Key country and sector recommended weights

to reasonable levels again But the long-term growth stories have not been damaged Mobile subscriber

growth in China, for example, will not be dented even if the US goes into recession The advantage of this

sector allocation strategy is that it should be fairly defensive in the event of further market turmoil, but

still partake in the ongoing Asian growth story over the long term and even perform well in the early

stage of a market rebound

Specifically, we like consumer-related sectors, such as retailers and food producers, particularly in

India, China and Korea Healthcare offers a perfect combination (for the current market) of

defensiveness and structural growth, aided by ageing populations and improving technology We like

pharmaceutical companies in Korea and Japan, but not in India We continue to favour telecoms, where

the structural growth story continues in India, China and some Asean markets like Indonesia and where

valuations, which were stretched three months ago, are now attractive again We like infrastructure

stocks, since in many Asian countries (Thailand, Korea, Taiwan, India, China) political considerations

will lead to a boost in government spending For similar reasons, we like steel – perhaps our most

contrarian call – because continuing demand from emerging markets means that producers should to be

able to raise prices to more than offset the rise in raw materials costs

Sectors we would avoid include: technology (too exposed to US consumption, with earnings expectations

that have just started to be cut sharply); financials (which we lower to underweight from neutral, since in

many countries NPLs are rising, net margins are falling, and more surprise losses in overseas securities

investment are possible), and cyclical exporters (because of the risk of further global economic

weakness) We have cut energy to underweight from neutral because, though crude oil prices may stay

high, governments’ moves to keep retail energy prices down will hurt profits since refiners may not be

fully compensated We are also cautious on resources (neutral) since we see metals prices being only

mixed over the next few months

Stock picks

For high-conviction buy ideas, too, our focus is on quality, blue-chip stocks, which are well positioned to

benefit from Asia’s long-term structural growth story but which will not suffer too much if markets

remain tricky Many saw share prices drop in Q1 and now represent excellent value For example, we

include two quality telecoms companies – China Mobile and Singapore Telecoms – as well as companies

that will benefit from consumption growth in China and Korea (respectively, New World, Maruti Suzuki

and KT&G) BHEL is a play on Indian infrastructure Our choices are mostly fairly defensive – although

we leaven this with the inclusion of Posco and Nanya Plastics

With markets having fallen so far, it is harder to find clear sell ideas than it was a quarter ago We

accordingly delete China Life and Angang Steel from last Quarterly’s list (both have fallen substantially

over the past three months) We replace them with two stocks that are still too expensive after previously

over-hyped expectations: Nalco and Eva Airlines

HSBC’s top 10 high-conviction buy ideas

region

to target price (%)

Price (local curr)

1 Apr

Market cap (USDm)

3328 HK BANK OF COMMUNICATIONS CO-H CH Financials Overweight (V) 22.0 9.26 (HKD) 27,422

BHEL IN BHARAT HEAVY ELECTRICALS IN Industrials Overweight (V) 71.8 1,892.20 (INR) 23,087

000640 KS DONG-A PHARMACEUTICAL CO LTD KR Healthcare Overweight 19.4 107,000.00 (KRW) 1,115

Source: HSBC

Top sell ideas

region

to target price (%)

Price (local curr)

1 Apr

Market cap (USDm)

Source: HSBC

Appendix 86

Disclaimer 92

Contents

What kind of bear?

“In theory, there is no difference between theory

and practice In practice, there is.” Yogi Berra

The first quarter was a peculiar one for Asian

stocks Economic fundamentals continued to look

strong (with average exports, for example, still

growing 12% y-o-y); earnings results for 2007

came in in line with expectations at 21%; and forecasts for 2008 earnings growth have stayed fairly steady Yet, MSCI Asia ex Japan fell 13%

in dollar terms over the quarter (15% in local currency terms) and the forward PE ratio derated from 15.6x at the end of last year to 12.1x at the lowest point in March

Investment strategy

 It seems fairly clear that we are in a new world: a bear market

 But what sort of bear is harder to tell What further consequences

of the credit crunch will emerge? Will the US recession be short or

drawn-out, shallow or nasty? How resilient will Asian growth,

particularly earnings growth, be?

 From an investor’s point-of-view, this may not matter In almost

any bear market scenario, investors should either (1) trade the

ups and downs, or (2) stick to quality stocks with good long-term

growth prospects, some of which are cheap again

1 MSCI Asia-Pacific and MSCI Asia ex Japan (in dollars) vs MSCI World

The theory of economic decoupling therefore

looks to have some validity but, in practice, global

risk aversion has meant that international

investors have pulled significant amounts of

money out of Asia (USD39bn in January-March

in the eight markets that provide data – which do

not include China or Hong Kong) With Asia

being a higher beta region than more developed

markets, it fell further – the US was down 10%

and Europe 11%

After a period of such shocks, it seems highly

unlikely, in our view, that markets will return to

normality smoothly We probably have to accept

that the bull market which began in April 2003

(or, some might argue, September 2001) is over

Through most of this period, economic growth in

Asia accelerated, earnings rose steadily, and

valuation multiples expanded (see Chart 2) Stock

market corrections were treated as opportunities

to buy Bad news was generally shrugged off

International investors increased allocations to

emerging markets; domestic retail investors in

many countries discovered the joys of equity

investment for the first time Investors were happy

to take more risk: fund managers who were too

cautious (with too much cash or too little

EPS PE (RHS)

Source: HSBC, Datastream, IBES

That world is over For the next few quarters, fear

will predominate over greed Investors will worry

about how much the US (and, by extension, the global) economy will slow, and about how long the side-effects of the dysfunctional credit markets will continue and where they will emerge next That means that volatility (which has risen

to 30-40% from the 10-15% level at the start of

2007, see Chart 3) will continue to be high, and the upside for the market will be, at best, limited compared to the past few years

3 Average 10-day historic volatility of Asia Pacific indexes

0 10 20 30 40 50 60

this year and 1.2% next – a double-dip shaped” pattern – but to avoid a technical recession In Asia, growth is likely to slip a little too but nonetheless remain impressive: we forecast overall real GDP growth for Asia ex Japan to slow to 7.8% this year and 7.8% again in

“W-2009, down from 9.1% in 2007 (see HSBC’s Q2

Asian Economics Quarter: The gathering storm

for details)

But bear markets – for that is probably what we

are now in – have their own dynamic They are

characterised by sharp rallies, as investors try to

pick the bottom, followed by scary plunges

Sector and style performance behave rather

differently to a bull market Bear markets tend to

drag on for longer than most people expect But

they don’t always produce dramatic declines in

stock indexes We will argue below that this is

likely to be a rather mild bear market for Asia

And bear markets do create opportunities too:

investors can make money by trading in and out

of the dips and rallies, or by focusing on stocks

that are attractive from a long-term perspective

but which get sucked down with the overall

market decline to become cheap

Is it a bear?

There is no clear definition of what differentiates

a market correction from a bear market

Strategists in the US usually define a correction as

a drop in the index of 10-20%, and a bear market

as a drop of more than 20% (on this basis, the

S&P500, which has fallen 18.6% from peak to

trough, is still only in correction territory)

Since Asia is a more volatile market (volatility

over the past 10 years has been 1.44x that of the

US), we would adjust those definitions to say that

a correction is a 14% decline, and a bear market a

decline of more than 29% On that basis, MSCI

Asia ex Japan just dipped into bear market

territory in March – at its low point it was down

29.6%

The pattern of the market over the past five

months, since its peak on October 29, has looked

more like a bear market than a correction too

Chart 4 shows the three corrections (using our

definition above) in the 2003-7 bull market (with

the market peak shown as 100 at Day 0); the

recent market movement shown in red In each of

the three corrections, the market bottomed within

25 days and had only one leg down

4 Corrections 2004-7

70 80 90 100 110 120

1994, 1997 and 2000 On these three occasions, it took 274, 304 and 448 trading days for the index

to bottom It fell in total 33%, 69% and 56% on these three occasions respectively It is important then, if we accept that the current market is a bear,

to work out what sort of bear We will come back

to this issue later

5 Bear markets in MSCI Asia ex Japan

30 40 50 60 70 80 90 100 110

-50 0 50 100 150 200 250 300 350 400 450 500

94 97 00 07

Source: HSBC, Bloomberg

We are not chartists and so don’t want to rely just

on what index trading patterns tell us But recent market fundamental characteristics also point to

this being a longer, more serious downturn than

just an intra bull market correction:

 Measures of risk aversion have continued to

deteriorate, despite the efforts of the Fed to

inject liquidity and rescue insolvent

investment banks The average spread on

Asian corporate bonds has risen to 350bp

from 240bp at the start of the year (Chart 6)

Equities have largely moved in line with this

measure of risk, except for a short period in

Q4 last year Our credit strategists argue that

the worst may be over for credit and that

spreads may peak this quarter, which could

provide support for equities Indeed, the

spread narrowed by about 20bps in the last

week of March after JP Morgan bought Bear

Sterns We believe, though, that the full

ramifications of the credit crunch have not yet

appeared: we expect new problems in the

areas of credit default swaps and private

equity, more write-offs from financial

institutions, and the first signs of trouble from

corporate borrowers struggling to raise funds

6 Asian dollar bond spread vs MSCI Asia ex Japan

MSCI Asia ex J ADBI spread (RHS, inv erse)

Source: HSBC, Bloomberg

 Global economic data is likely to weaken

further Our economists expect real GDP

growth in the US to drop to -0.5% q-o-q

annualised in Q2, after 0.5% in Q1 and 0.6%

in Q4 2007 It is one surprising factor in the

past few months that US cyclical indicators

have not (yet) fallen sharply The manufacturing ISM index, for example, remained at 48.6 in March, only just below the cut-off line of 50 (Chart 7) It seems inevitable that this will fall to at least 45 over the coming months Although the correlation

of Asian equity markets with the ISM has weakened somewhat recently (decoupling?),

it is hard to imagine that a further fall in the ISM would not worry investors in Asian stocks

7 US ISM Manufacturing index vs MSCI Asia ex Japan

40 45 50 55 60 65

 Monetary policy will be complicated by

inflation Although the Fed is aggressively cutting rates, in Asia Pacific, some central banks are still focused on combating inflation:

Australia and Taiwan both raised rates in March; China, Vietnam, and Indonesia remain in tightening mode With average Asian inflation (ex Japan) having risen to 6.3% in February (see Chart 8), central bank decision-making is not straightforward And this environment is throwing up other problems: a shortage of rice throughout the region, government controls on retail prices

of essential goods which could negatively affect the profitability of producers, extreme currency movements (for example, in Korea

or Vietnam in March) as foreigners chase high-yielding instruments in appreciating currencies, and increasing difficulties in

sterilising currency intervention as US rates

fall below those in Asia

8 Average CPI inflation in Asia ex Japan

 Foreign flows Risk aversion means that an

unprecedented amount of capital has been

withdrawn from Asia over the past few

months (Chart 9) This year so far, foreign

investors have sold USD20bn of Japanese

stocks, USD14bn of Korean ones and

USD3bn in India Only Taiwan and Vietnam

have escaped the sell-off Emerging Portfolio

Fund Research reports that Asia ex Japan

mutual funds globally saw outflows of

USD12bn in Q1 (and Japan funds outflows of

USD6bn) China and Greater China funds, in

particular, saw outflows of USD5.4bn After

that degree of selling, past experience is that

it takes around six months before retail

investors have enough confidence again to

start to put their money back into the market

Mutual funds are unlikely to be significant

buyers of Asian equities for a while yet By

contrast, money market funds saw a

remarkable USD141bn of inflows during the

quarter

9 Cumulative net flows into Asian equities

-50 0 50 100 150 200 250 300 350

aggressively to take risk again In a sense, over the coming months bad news will be good news because it will mean the market is getting closer

to absorbing all that the global environment has to throw at it Clear signs of a US recession, further large write-offs by banks or news of new distress

in the credit market would, paradoxically, be welcome because they would bring us nearer to the end of the worst

What do bears look like?

Bear markets typically go through six phases:

 Denial Investors remain euphoric after a long

run-up and treat the market decline as a buying opportunity This happened in November and December last year, when equity markets in Asia rebounded despite worsening credit market conditions

 Inaction Investors become confused and

professional fund managers, in particular, sit

on their hands as they puzzle how to handle the situation This happened from late 2007,

as witnessed by declining turnover in Asian markets (Chart 10)

10 Total daily turnover (USDbn) of Asia ex Japan markets

 Panic Investors realise they are losing

significant amounts of money and start to

offload shares This happened in the early part

of 2008, especially among retail investors in

Hong Kong (who had leveraged

“accumulator” positions on H-shares) It may

be happening now in China, India, and

Vietnam This can be accompanied by an

increase in volumes, as stock sales hit the

market

 Bottom-spotting At quite an early stage in

the bear market, investors start to play the

game of anticipating where it will bottom If

you get this right, it can be very profitable

since the first leg-up of a recovery is often

extremely sharp The process of

bottom-spotting generally causes sharp rallies In the

2000-1 bear market, for instance (see Chart

11), there were five rallies of 10% or more

This time, there have already been two

(January-February and late March)

11 Rallies in the 2000-1 bear market

150 200 250 300 350

 Capitulation The bottom-spotting rallies

peter out leaving even more investors depressed about the long-term future of equity investment Retail investors put their money

in bank deposits, institutional funds raise their cash holdings, strategists talk about this being the worst bear market for 50 years In our view, we haven’t reached this stage yet this time

 The rebound, when it comes, often doesn’t

require a specific catalyst, just enough people

to have turned bearish and valuations to have got cheap enough that the attraction of equities reappears

But what sort of bear?

The three previous bear markets in Asia were all very different in nature as well as in magnitude (as can be seen by referring back to Chart 5, and well as from Chart 12 below)

 1994: shallow The 1994 bear market was

triggered by excess valuations in Asia (forward PE for Asia ex Japan had reached 25x), and by the Fed raising rates sharply as the US came out of recession US economic growth slowed moderately in 2004-5, but Asian growth remained resilient The market peaked in January 2004, continued to drift off until January 2005, and then bounced only

fairly weakly over the following year, rising

30% – it did not regain its 1993 high until

2007!

 1997: short and nasty The 1997 bear

market, which began in July 1997, was

caused by structural economic problems in

Asia (and was largely unlinked to events in

the rest of the world) The index fell 60% in

the first six months, rallied but then had

another leg down, before bottoming in

September 1998 The recovery was equally

steep, driven by the TMT bubble – but again

did not get back to the 1997 peak until 2006

 2000: deep and protracted The 2000 bear

market was the reaction to high valuations

and excess capital spending globally during

the TMT bubble in 1999 It was the most

protracted of the three, lasting from February

2000 to October 2001 It then had a 50%

rally, but almost sank back to its October

2001 low again in both October 2002 and

So what will this bear market be like? For the

moment, we think it is hard to tell The length and

depth will depend on many factors:

 How much the US economy slows and for

how long Our economists’ forecast of a

W-shaped growth trajectory, would suggest a

pattern like 2000-3 in Asia, where stocks rebound, as they did in H1 2002, on the belief that the US economy is recovering, but that ultimately this belief proves to be unfounded and they give back (most of) their gains This

is not an unfeasible scenario for the second half of this year if the Fed’s rate cuts and fiscal stimulus have a (temporary) positive effect on growth

 How immune Asia will be from the global slowdown (the decoupling argument)

 To what extent further bad news emerges from the dysfunctional credit market

 How far the Fed will be prepared to go to bail out ailing financial institutions (including perhaps, later, hedge funds or other investment institutions)

 How big a psychological impact the Fed’s actions will have on banks’ willingness to lend, consumers’ enthusiasm to spend, and corporate managers’ judgement on capex

 How much earnings are cut in Asia

Risk aversion, not earnings recession

So far at least this bear market has been marked purely by risk aversion, and has not been accompanied by a significant slowdown in earnings growth It is true that analysts’ forecasts for 2008 EPS growth have slipped to 8.4%, down from 10.5% at the end of last year (and much lower than 2007’s 20.8%) But mostly this is due

to a base effect, since last year’s results came in a little above consensus forecasts and, at this time of the year during the results season, it can take analysts a while to adjust next year’s forecasts In absolute terms, 2008 EPS has been cut just 3%

from the peak in November As Chart 13 shows, earnings forecasts are no longer being revised up

as they were throughout 2007 – but neither are they being slashed

13 Consensus forecasts of Asia ex Japan EPS by year

'06

Source: HSBC, Datastream, IBES

This is a very different experience to previous

bear markets In 1997, for example, by November

– only four months after the market had peaked –

analysts had already revised down their 1997

estimates by 25% and 1998 estimates by 22%

Within six months of the market peak, 1997 and

1998 forecasts had been lowered by 46% and 31%

respectively

Analysts were almost as quick in 2000 The stock

market peaked in February 2000, and the US

economy started to slow only in March 2001

(according to the NBER definition of a recession)

But by July 2000, analysts had already cut their

forecasts for that year by 17% and for 2001 by

21% Admittedly, 2000 came in 16% worse in the

end than analysts believed in July, but they cannot

be accused of reacting slowly

Patterns for the rest of 2008

An aid to thinking about risk aversion versus

earnings growth is shown in Chart 14 Here

possible index changes in 2008 (starting from 1

January, not from now) are shown as a factor of

(1) EPS growth on the x-axis, and (2) the year-end

PE on the y-axis The index change at each

combination of PE and EPS growth is shown by

the horizontal curves

It is clear here how the decline in the first three

months of the year was caused mostly by a falling

PE (i.e risk aversion) rather than by deteriorating growth expectations PE fell from 15.6x at the start of the year to 12.4x; EPS growth expectations have been cut from 10.5% to 8.4%

Put another way, if PE had stayed at its end-2007 level through the first quarter, with the earnings growth the consensus now expects, we would still

be looking at a market return for the year of 8% or

so

14 Earnings growth and valuation scenarios

10 11 12 13 14 15 16 17 18

What possible scenarios are likely from here?

Given the uncertainties we described above, only

a fool would claim to have a clear idea of the exact trajectory of the market over the next nine months We would offer three possible paths for this bear market:

 Scenario A: “Asian economic decoupling”

Earnings stay robust, with analysts seeing no need to cut forecasts But credit market worries and further withdrawal of foreign funds from Asian markets cause PEs to fall further Asian stock markets fall further to year-end

 Scenario B: “Bouncing along the bottom”

The worst of the credit crunch is over in Q2 and so risk aversion eases a little, allowing PEs to rise slightly However, a mild slowdown in the US causes Asian earnings expectations to be moderately revised down

Asian stock indexes pick up modestly in H2

 Scenario C: “The nasty bear” The credit

crunch continues to worsen and, in the face of

a sharp global slowdown, Asian earnings

growth is at risk Analysts cut forecasts

aggressively The index falls further

The other feasible possibilities on the chart –

significant upwards revisions to earnings, or a

dramatic recovery in risk-taking which pushes PE

up to where it was at the start of the year – seem

highly unlikely to us

The three previous bear markets showed very

different patterns (Chart 15) In 1994, earnings

growth was about flat but PE fell by 20% The

1997 bear market saw the nastiest combination of

a big fall in earnings plus multiple contraction, but

in the following year PEs rebounded although

earnings fell further In 2000, earnings continued

to grow robustly but valuations were dramatically

derated as the tech bubble burst; note, though, that

earnings did fall sharply in 2001, when PEs

remained at their lower level

15 Annual return, disaggregated into change in PE and EPS

07 06 05 04 03

02 01

00

99 98

97

96 95 94

Source: HSBC, Datastream, IBES

The result is the same

In a way, once we have agreed that the next year

or so will continue to be difficult, the exact type

of bear market doesn’t matter very much from the

point-of-view of investment strategy or asset

allocation (For what it is worth, we see as the

most likely scenario a further leg-down in the

second quarter, followed by a recovery in H2 as

US economic data start to look better and credit concerns ease, but then a further period of weakness next year as bank lending and risk-taking globally remain cautious and the US economy double-dips That is why we have index targets for end-2008for MSCI Asia Pacific only 1% above the level – although we are a little more optimistic on MSCI Asia ex Japan, where we target a 10% rise In terms of the scenarios above, this would look like A, followed by B.)

Whatever the trajectory, we see only two ways that investors can approach this market – both very different from how one should behave in a bull market

 Aggressively trade the rallies and dips Get

the timing right and this can be very profitable – although it is also hard There will be individual country or sector themes that will run for a few weeks The whole Asian market will get over-sold or excessively cheap from time to time (To allow ourselves to help clients in these decisions, from this Quarterly we have simplified the way we present our sector and country recommended weightings, which will allow us to change them quickly intra-quarter, whenever we see an attractive opportunity.)

 Stick to long-term growth stories – many of

which will be available to pick up from to-time at bargain-basement valuations The old Asian stories of the past few years – endogenous growth, the growing middle class, increased infrastructure spending, more sophisticated financial services, the

time-development of global brands, improvements

in home-grown technology – will not go away But our advice would be to stick to quality: blue-chip companies, with strong balance-sheets, good management, a leading competitive position in their markets, and

often with an attractive dividend yield In the

country pages and the sectors and stocks

section of this Quarterly, we have tried to

identify such themes

As far as country allocation is concerned, we stick

to some of the themes we identified in our Q1

Preview of 2008:

 Implications of monetary policy Countries

with dovish central banks and only moderate

inflation will look more attractive for equity

investors than those where the central bank is

particularly hawkish or where inflation is

getting out of hand

 Endogenous growth We prefer markets with

domestically driven growth, and low

dependence on exports

 A sprinkling of value One lesson of Q1 was

that when markets get too expensive (as, for

example, India or Malaysia clearly were),

they can sell off dramatically on only mildly

negative news (sadly, this doesn’t seem to

work in reverse with very cheap markets)

 Political change Looking for non-correlated

reasons for a country to perform (“market

alpha” perhaps), political change is the easiest

to spot This was why Taiwan and Thailand

were the two best performing markets in Q1 (although Korea has yet to reflect what we see

as the much better political outlook presented

by its new president – but perhaps it will if his party wins a majority in the parliamentary election on 9 April)

In the new market environment, ideally we would want to invest in countries with all these

characteristics We have tried to quantify them approximately in Table 16 For each category, we scored from -3 to +3, based on the impact on the stock market We weighted the categories, depending on how important each was in the current environment (for example, the long-term growth story is probably less important currently than the lack of structural worries)

Readers will doubtless disagree with our judgements, but this scorecard enables us to make

a rough call on which markets now look attractive (Thailand, Singapore, and China, for instance), and which are better avoided (Japan, Vietnam, the Philippines, and Australia) We loosely based our country weight recommendations this quarter on these results

16 Market scorecard

Monetary

policy

Earnings visibility

This page has been left blank intentionally.

No big downward revision yet

Despite the recent fall in stock markets, earnings

forecasts have remained remarkably resilient EPS

growth in 2007 seems to have come in roughly

where analysts forecasted three months ago, 21%

But, more importantly, the 2008 forecasts have

hardly budged: they have been revised down just

1% over the past three months, with analysts now

expecting 8% growth this year for Asia ex Japan

(compared to 11% at the time of the last quarterly

Within these numbers, however, there is quite a

lot of divergence between markets The more

cyclically-sensitive economies have indeed seen

downward revisions (Table 5) Most notably,

analysts have revised down 2008 (calendarised)

forecasts for Japan by 12% over the past three

months However, in our view, the current

forecast of 9% growth for this year will be hard to

achieve in the face of the strong JPY From a

top-down perspective, we forecast that Japanese

earnings will decline this year Forecasts for

Taiwan, Australia, and Korea have also been

revised down over the past few months

By contrast, forecasts for China and India

continue to be revised up slightly, by 2% and 1%,

respectively, over the past three months The

consensus forecast for MSCI China this year (EPS

growth of 21%) seems achievable to us if

currency appreciation (say, 8% in 2008) and a

corporate tax cut (which raises net profit by about 6%) are taken into account The forecast of 20%

growth in India, however, may be a little harder to achieve if economic growth slows, as we forecast,

to only 7% and if the central bank does not cut rates

But as a result of these changes, there has been a slight deterioration in earnings momentum (Chart

3 – the change over the past six months in the month forward EPS forecast) Partly because this year’s growth is forecast to be only half of last year’s, momentum has slipped from a peak of 14% late last year to only 9% and will slip further unless 2008 forecasts are revised up The market has in the past reacted quite sensitively to momentum It is also slightly concerning that 57%

12-of analysts’ revisions have been downward since the start of the year (Chart 4) Downward revisions have been particularly noticeable in Taiwan (79% of all revisions) and Korea (62%)

On the other hand, analysts continued to revise up

in India, Hong Kong, Indonesia, and Malaysia

Our conclusion is that so far there are few signs of

an earnings recession, although more significant downward revisions are possible in the coming months

Earnings

 2007 EPS growth came in roughly in line with forecasts

 Forecasts for 2008 have been remarkably stable

 But there are signs of downgrades in Japan, Taiwan and Korea

1 12-month forward EPS growth vs MSCI Asia ex Japan 2 Consensus forecasts for EPS growth

EPS growth MSCI AEJ index y/y (RHS)

Consensus forecasts for EPS growth

2007 2008 2009 Australia 7.2 8.2 10.9 China 28.6 21.4 16.0 Hong Kong 39.1 -22.9 15.4 India 14.6 20.2 24.4 Indonesia 55.3 18.1 16.7 Japan 6.7 9.0 9.1 Korea 5.6 14.6 14.3 Malaysia 43.0 -9.2 11.4 Philippines 3.2 13.0 18.8 Singapore 20.5 -4.5 12.4 Taiwan 29.9 6.6 10.6 Thailand -29.4 100.7 7.4 Asia ex-Japan 20.8 8.4 14.6 Asia Pacific 16.4 7.7 12.2

Source: Bloomberg, I/B/E/S, HSBC Source: I/B/E/S, HSBC

Source: I/B/E/S, HSBC Source: I/B/E/S, HSBC

Country Vs 3 Months ago Rank Vs 6 Months ago Rank

IT -1 7% 9 -1 5% 9 Utilitie s -4 3% 10 -10 8% 10

A s ia Pac 2 2% 3 6%

Source: I/B/E/S, HSBC Source: I/B/E/S, HSBC

Massive derating

Asia ex Japan multiples have been massively derated

over the past few months From a peak of 17.6x in

October last year, the 12-month forward PE has

fallen to only 12.4x (Chart 1) This is, however, only

roughly in line with the average since 2001, although

it is one standard deviation below the average since

1993

Japan, Australia, Singapore, and the Philippines look

particularly cheap relative to history Only

Indonesia, Korea, and India are significantly above

their post-2001 averages

Moreover, relative to expected EPS growth rates,

most markets now look cheap (Chart 3) Only Hong

Kong, Singapore, and Australia have PEG ratios

greater than one Analysed by PB relative to the

ROE/COE spread (Chart 4), we find that Singapore,

Korea, and Australia look particularly cheap, while

India and Indonesia look pricey

We have made some changes this quarter to our

three-stage dividend discount model (Table 5)

We updated our equity risk premiums (which are

calculated from the relative volatility of each market

to the US over 10 years) As a result of a slightly

changed calculation methodology and higher

volatility since last summer, ERPs have generally

risen (for China, for example, to 7.5% from 6.5%)

However, the fall in the risk-free rate (we use year US treasury yields for all markets except Australia) has largely cancelled this out, leaving COEs unchanged in most cases We also tweaked our assumptions for growth in stage 2: for example,

10-we lo10-wered the assumption for China to 13% EPS growth continuing for 12 years (before a five-year fade to 6%) – previously we assumed 14% for 15 years

On the new numbers, only Indonesia, Thailand, and Korea look overvalued – and these would easily fall into fair value territory if volatility were to decline as

a result of structural change For example, in Korea

we use an ERP of 8%, but the market would be at fair value if an ERP of 6% (the same as Taiwan) is used – given the growing maturity of this market and lower volatility than in the 1990s, investors might think this is a rational choice

Singapore, Australia, Malaysia, and China now look very good value on the basis of this analysis For MSCI China, for instance, we can justify a fair PE of 15.5x – currently the market is trading on only 12.4x Something similar would be true for Thailand, if the political situation stabilises

Indonesia, on the other hand, has a fair PE of only 9.9x, while it trades on 12.5x This is the one market that, in our view, clearly looks overvalued

Valuation

 Asia ex Japan prospective PE has fallen to 12.4x from a peak of

17.6x

 Most markets – except perhaps Indonesia – now look cheap

 We have refreshed the methodology of our discount model

1 12-month forward PE – Asia ex Japan 2 Current forward PE versus historical averages

Forward PE - Asia ex-Japan

PER now Average 2001- % difference Average 1993- % difference

Source: Bloomberg, I/B/E/S, HSBC Source: Bloomberg, I/B/E/S, HSBC

APAEJ

TH

TW SGPH MYKR

IN HK

CH AU

IN

PH

ID

MY SG KR

CH

TW HK

1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

PBR

ROE/CO

Source: I/B/E/S, HSBC Source: Bloomberg, I/B/E/S, HSBC

5 Dividend discount model

Massive foreign selling

Foreign investors have been huge net sellers of

Asian equities over the past few months Since the

start of this year, they have sold USD20bn net in

Asia ex-Japan and another USD19bn in Japan

In our view, what is particularly significant about

this is that it is the first time in history that markets

have seen such sustained selling As Chart 1 shows,

foreigners were not big sellers in the 2000-2003

recession and even during the Asian crisis, outflows

from Korea and Taiwan (the only markets for which

data then was available) were limited

The foreign selling this time has been focused

particularly on Korea, which has seen USD14bn of

outflows this year, after USD12bn last year Since

the beginning of 2005, foreigners have offloaded

USD61bn of their Korean holdings (mistakenly in

retrospect since the market has doubled in that time)

By contrast, India has seen outflows of only

USD3.9bn this year, and Taiwan has even seen a

small inflow as foreign investors bought into the idea

of cross-straits relations improving as a result of

recent elections

Official flow data is not published for markets such

as China and Hong Kong, but we can estimate from

data for global mutual funds collected by Emerging

Portfolio Fund Research that these saw substantial

outflows too Over the three months to end-January,

for example, mutual funds sold net USD2.7bn of

their Hong Kong holdings and USD2.0bn of Chinese ones

Given the difficult market conditions, equity issuance has unsurprisingly slowed sharply, with many IPOs being cancelled In the first three months

of the year, Asian equity issuance (both IPOs and secondary) totalled only USD15.7bn – on an annualised basis that is 85% down from last year’s level (Table 3) Only India has seen issuance at last year’s level – one reason we believe why this market has performed poorly since January

In some markets, domestic retail buying has provided support Despite the market turmoil, Korean individuals have put KRW17.3trn into equity-related investment trusts this year to-date In Taiwan, domestic-focused funds have seen inflows

in the past couple of months (where last year investors were interested only in overseas funds) As

a result, since the start of February, Taiwanese mutual funds have bought net TWD15.3bn of local equities

The picture is not so happy in Japan and China, however Japanese investors (Chart 4) continue to pull money out of domestic equity funds (partly because tighter regulations make it harder for financial institutions to sell them) In China, the promised wall of QDII money has not materalised yet, as investors were put off by falling markets It is likely to appear, once markets settle

Supply and Demand

 Foreigners have sold USD39bn of Asian equities so far this year

 Equity new issuance has almost dried up – except in India

 In Korea and Taiwan, domestic investor buying is a support

1 Cumulative net buying by foreign investors since 2000 2 Foreign net buying by markets 2007

Japan Asia ex-Japan

Foreign investors' net investment in Asian equity markets

Source: Bloomberg, HSBC Source: Bloomberg, HSBC

3 Total equity issuance by market 2004-7 4 Net inflows into Japanese equity investment trusts

(USD bn) 2005 2006 2007 2008 YTD 08 (ann) v 07

(Ybn)

Stock IT

Source: Bloomberg, HSBC, 2007 TD data till 09 Dec 07 Source: IT association, HSBC

5 Net inflows into Korean equity-related investment trusts 6 Net inflows into Indian mutual funds

Mutual Funds Net Flow

Attention shifts to India, Japan

The past few months have been a season of

elections No fewer than five markets have held

important elections recently: Australia, Thailand,

Korea, Taiwan, and Malaysia At least three of

these produced market-positive results We

believe Korea’s new president, Lee Myung-bak, is

likely to implement a programme of deregulation

and infrastructure spending, particularly if his

party wins a majority in legislative elections on 9

April In Thailand, a new democratic government

emerged after 16 months of military rule And in

Taiwan, the KMT’s victory in January’s

legislative election and its candidate’s victory in

the presidential election, raise hopes of better

relations with Beijing Only Malaysia’s general

election, where the government’s share of seats

fell to 63% from 90% was a shock for the market

– although we think the market has over-reacted

to the risk that this result presents

There are two other possibly political events to

come later this year India’s government does not

need to call a general election until May 2009 but,

judging by its recent populist budget, will

probably hold it in the second half of this year

We believe this represents a short-term negative

for the markets (which tend to get nervous ahead

of elections) but a potential long-term positive if

either Congress (minus its left-wing coalition

partners) or the BJP were to win a majority

In Japan, the government may call an election after the G8 summit (to be held in Hokkaido in July) in order to break the current deadlock in parliament, where its lack of a majority in the lower house is making it nearly impossible to pass legislation This could lead to a realignment of politics, particularly if the ruling LDP were to lose that election and a coalition of the Democratic Party of Japan plus reformist LDP dissidents took power

Meanwhile, non-political risk has been a major driver of markets The measures from the fixed-income markets we look at to judge risk pricing continue to deteriorate dramatically The spread

on Asian dollar bonds, for example, has widened

to 350bp from 120bp before the credit crunch started last year (Chart 3) The spread is wider than at any point during the 2000-2003 recession, although still a long way away from the 900bp it reached during the Asian crisis

Our colleagues in fixed-income strategy see credit spreads as likely to peak during Q2 – something which might be a positive signal for Asian equity markets, since there has historically been a close correlation between the stock prices and risk indicators

Politics and risk

 Elections in Korea, Taiwan, and Thailand were market-positive

 Elections in India and Japan later this year are harder to call

 We look for credit risk to bottom out in Q2

1 Average sovereign credit rating – Asia ex Japan 2 S&P long-term foreign currency credit ratings

Source: Bloomberg, HSBC Source: Bloomberg

3 Spread on Asian USD bonds vs MSCI Asia ex Japan 4 Government approval ratings

0 20 40 60 80

Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

KR TW AU JP HK

Source: Bloomberg, HSBC Source: Various polling organisations and media, HSBC

5 Political snapshot of Asia Pacific markets

Country Head of government Latest

approval rating Next significant political events Consensus view of result

Australia Kevin Rudd (PM) 70% Parliamentary election by Dec 2010

Hong Kong Donald Tsang (Chief Executive) 64% Legislative Council election Sep 2008

India Manmohan Singh (PM) 77% Probable early election in mid-2008 Unclear

Indonesia Susilo Bambang Yudhoyono (President) 56% Presidential and legislative election Jun

2009

Susilo Bambang Yudhoyono to win majority

Japan Yasuo Fukuda (PM) 34% Possible general election in H2 2009 Government may lose majority

Korea Lee Myung-bak (President) - Parliamentary election April 9 GNP to win majority

Malaysia Abdullah Ahmad Badawi (PM) - Parliamentary election by 2012

Philippines Gloria Macapagal-Arroyo (President) 29% Presidential election 2010

Singapore Lee Hsien Loong (PM) - Parliamentary election by 2011 People's Action Party stay in power

Taiwan Ma Ying-jeou (President Elect) - Legislative election 2012

Thailand Samak Sundavavej (PM) n/a Parliamentary election by end-2011

Source: Various polling agencies and media, HSBC

This page has been left blank intentionally.

Country profiles

Gloomy and depressing

MSCI Japan outperformed MSCI Asia-Pac in

dollar terms by 5% in Q1 However, we believe

this is because Japan had already underperformed

other Asian-Pac markets since February last year

and because of the rise in the yen against the dollar

(+11%), rather than for any particularly positive

reasons TOPIX was down 22% in local terms

Being one of the most cyclical markets in Asia and

among developed markets, the main driver of the

Japanese stock market is global growth and

earnings growth; however, both continue to

deteriorate Reflecting a downturn in US and

global growth, our economist recently revised down Japanese real GDP forecasts to 1.2% and 1.4% for the current year and next year respectively The economy peaked last summer and is now entering a light recession

Corporate earnings have already shown signs of deterioration Earnings momentum started to slow last summer and turned negative in February (earnings were revised down compared to six months ago) In the first half of FY07, Japanese companies enjoyed the benefit of a weak yen but, with the sharp rises in the yen, earnings growth is

on the edge of a cliff CAO’s Annual Survey of Corporate Behaviour in FY06, which was

Japan (underweight)

 Economy is in light recession and earnings forecasts are falling

 There is little chance of a political breakthrough, and corporate

governance is deteriorating

 Valuations are cheap compared to history but even domestic

investors are steering clear

Key financial and economic forecasts

Return (%, USD) MSCI Japan TOPIX Economic forecast 2008 2009 Valuations 2008 2009

1Q08 sector performance (%) Absolute Relative Earnings (%)

Source: HSBC, I/B/E/S

conducted in January last year, showed that

JPY106 to the US dollar was the average rate at

which exporters thought they would be able to

operate profitably We expect earnings forecasts

for FY08 will be revised down in the coming few

months We estimate top-down that, if the yen

remains at the current level (USD/JPY=100 and

EUR/JPY=155), sales growth for FY08 will be

-3% and operating profit -6%

The government won’t be able to provide any help,

and may make things even worse Political turmoil

due to the split parliament is blamed for the

vacancy of the BoJ governor In addition, the Diet

failed to take legislative action to extend the

provisional gasoline tax surcharge Public support

for the Fukuda Cabinet has fallen to 34% after a

series of fiascos

Valuations are the cheapest in history: 12-month

forward PE has dropped to12x, which is roughly

in-line with Asia-Pacific markets However, given

that earnings are likely to be revised down further,

the reality is not cheap as this figure suggests

Another negative is absence of domestic buyers

Performance of the Japanese market depends on

foreigners, who account for 70% of trading

volume on the Tokyo Stock Exchange Foreigners

have sold a total net JPY4.2trn since end-July last

year The amount they sold was as large as the

JPY5.2trn in March 1989-October 1990 when the

Japanese bubble burst Domestic life insurers and

pension funds are likely to continue to lower their weightings in Japanese equities

Until there is a global cyclical rebound or major political change, we will continue to be negative

Sectors and stocks

We largely maintain a defensive stance and

continue to avoid cyclical sectors where earnings

will be revised down the most due to the stronger yen and higher materials costs, although

underlying demand does not show any deterioration at this stage We are underweight the

tech and consumer discretionary sectors Our

autos and electrical machinery analysts forecast these sectors will see net losses if USD/JPY trades

at the 100 level throughout the next fiscal year

We are overweight on defensive sectors such as

healthcare, where the sector trades below the pan-Asian sector average Consumer staples

looks pricey with the recent outperformance of the sector

Sectors weightings and stock screening

Cons Disc Underweight Aisin Seiki Co Ltd, Toyota Boshoku Corp, Nissan Motor

Cons Staples Overweight

Energy Neutral

Financials Neutral Sumitomo Mitsui Financial,Resona Holdings Inc Nipponkoa Insurance Co Lt,

AIOI INSURANCE COMPANY

Industrials Neutral Asahi Glass Co., Ltd., Ulvac Inc

Technology Underweight Matsushita Electric Indus, Sharp Corp Nintendo Co., Ltd

Telecoms Overweight NTT, KDDI Corp

Utilities Neutral

(Stocks shown are those with market cap above USD1bn, where HSBC’s analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current

stock price Up to three stocks are shown in each category for each sector For latest prices of covered stocks see Appendix 1.) Source: HSBC

Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08

Cyclicals Defensive Energy

Asia- Performance led by energy outperformed MSCI Japan index by 5%

 Worse performing sectors were technology and telecoms; both dropped by 25%

GDP growth revised down since summer

 The consensus estimates for 2008 and 2009 real GDP growth are +1.3%, +1.8% respectively

 Our economists revised down real GDP growth forecasts to +1.2% and +1.4% respectively in 2008 and 2009

 We see a 25bp interest rate cut in April-June quarter

Source: Consensus Economics, HSBC

JP Econ Performance Index MSCI JP (RHS)

Mild recession in the first half

 January machinery orders was much higher than expected (+19.6% m-o-m, +11.4% y-o-y) but we expect a sizable m-o-m decline in February

 January industrial production was lower than expected (-2.0%, m-o-m) Industrial production peaked in last summer

 Exports up 7.7% y-o-y in January but export volume to US dropped 17% y-o-y and export volume to Asia, especially to China, slowed

Source: Bloomberg, MSCI, HSBC

Consensus forecasts looks too optimistic

 The IBES consensus forecasts +9% EPS growth in 2008 and 2009

 The March edition of Toyo Keizai Japan Company Handbook revised down operating profit forecasts for FY08 to +4.3% from +7.0% in the December edition

 Earnings forecasts revised down the most in electricals and precision

Source: I/B/E/S, HSBC

Japan 6-month earning momentum

Momentum turned negative for the first time since early 2002

 Earnings momentum continued t o decline from early spring 2007 and turned negative in February

 Main reasons are higher material costs, appreciation of the yen against the

US dollar, introduction of revised Building Standards Law and slower growth in

PE trades below Asia-Pacific

 Japan now trades on a 12-month forward PE of 11.7x, cheapest in history

 That is below Asia-Pacific average PE of 12.6x

 Dividend yield is 1.7%, well above 10-year JGB yield of 1.3%

Industrials

Cons.

discr

Materials

12-month fwd PE 5-year PE mean

Defensive sectors getting pricy

 Except utilities sector, all sectors now trade below their five-year mean

 Financials and industrials look particularly cheap compared to history

 Utilities, consumer staples, IT are trading higher than their Pan-Asian peers

Foreign net outflow continues

 Japan saw net foreign outflow of JPY1.9trn in Q1 Since foreigners turned net sellers in late July, they have sold net JPY4.2trn

 Domestic institutional investors have no interest in Japanese stocks

 Corporates have been buying back shares: they have bought JPY760bn so far this year

Source: EPFR, HSBC

Higher rates, lower growth

We lowered Australia from overweight to neutral

last quarter, on the grounds that it was likely not

to prove as defensive as in the past That has

proved to be the case in Q1, when the market

underperformed Asia Pacific and was pulled

down especially by worries about bank exposure

to asset-backed securities

We continue to worry about the fundamentals in

Australia, and so have lowered our weighting

further to a small underweight Most worrisome is

that the Reserve Bank seems to be the last central

bank on earth still raising rates In early March, as

the Fed was cutting aggressively, it raised a

further 25bps to 7.25% We forecast a further

25bps rise over the coming months True, there

are some good reasons to raise rates: CPI is up 3%

y-o-y and the labour market remains tight with unemployment at 4%, a 40-year low But worryingly, the economy is showing some signs

of softness: business confidence has fallen to a six-year low of -2, and Q4 GDP came in an annualised q/q rate of only 2.4% Deputy governor Malcolm Edey admitted recently that there are “significant dampening forces at work”

There is a risk, then, that the Reserve Bank has raised rates too far too long and that this will start

to impose a drag on the economy Certainly, with 10-year government bonds still yielding 6% (see Chart), and banks lending at about 10%, rates appear to be a significant negative for both the economy and stock market valuations

Australia (underweight)

 Australia may not be as defensive this time as traditionally

 It is very dependent on commodities – and has a lot of banks

 Also, its central bank is one of the most hawkish in the region

Key financial and economic forecasts

Return (%, USD) MSCI Australia S&P/ASX 200 Economic forecast 2008 2009 Valuations 2008 2009

Source: HSBC, I/B/E/S

Australian and US 10-year government bond yields

This is not to say that the Australian market is

likely to crash Valuations now look cheap, with

12-month forward PE at 12.0x the lowest for more

than a decade And that is based on fairly

reasonable earnings growth forecasts of 7% this

year The market is also supported by the large

superannuation fund industry, which provides a

firm domestic investor base But remember, too,

that Australia is quite cyclical, with high

dependence on commodity-related earnings It

also has a high weighting in financials, and banks

that have been aggressive overseas could be

sitting on problems

Inflection points

Direction of commodity prices

Further tightening by the Reserve Bank

Impact of credit crunch on Australian banks

Source: HSBC

Sectors and stocks Commodity prices remain an important driver of the market (the two largest resources stocks comprise 23% of market cap, and 32% of this year’s forecast earnings) In our view, commodity prices will be mixed over the coming months, with some industrial metals such as zinc and nickel likely to fall, but with bulk commodities (iron ore, coal) probably remaining strong In this environment, we recommend a market-neutral

weighting in the materials sector

We are lowering our weighting on financials

(which make up 39% of the market) from neutral

to underweight While the sector has already underperformed significantly and now looks fairly cheap, analysts’ forecasts of 6% EPS growth in

2008 seems too optimistic in the current environment of write-offs We would also avoid

the consumer discretionary and industrials

sectors, where exposure to the US consumer is

fairly high Our only overweight is in consumer staples, since basic domestic consumption should

remain robust

Sectors weightings and stock screening

Cons Disc Underweight

Cons Staples Overweight

(Stocks shown are those with market cap above USD1bn, where HSBC’s analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current

stock price Up to three stocks are shown in each category for each sector For latest prices of covered stocks see Appendix 1.)

Source: HSBC

Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08

Main index

Financials the worst performer

 MSCI Australia has fallen by 10.5% in three months, underperforming MSCI Asia Pacific by 1ppt

 Financials was the worst performing sector, on worries about Australian banks’ exposure to asset-backed securities

 Every sector fell except energy which rose 5%

 That represents a sharp slowdown from 3.9% last year

 The consensus expects a further slowdown to 3.2% next year

Source: Consensus Economics, HSBC

AU Econ Performance Index MSCI AU (RHS)

…with short-term indicators softening

 The Economic Performance Index for Australia has drifted off in the past few months, down 2% over the quarter

 Consumer and business sentiment indicators have generally weakened slightly

 Much still depends on the outlook for commodity prices

Source: Bloomberg, MSCI, HSBC

Resources forecast to see falling earnings

 Australian EPS is forecast to grow 8.2% this year after 7.2% in 2007

 Telecoms (+15%) and the small IT and healthcare sectors are forecast to see the strongest earnings growth

 Earnings declines are forecast for the key materials (-1%) and energy (-6%) sectors

Source: I/B/E/S, HSBC

Australia 6-month earning momentum

…but elsewhere stable

 Earnings momentum is not strong, but it is at least fairly stable

 The 12-month forward EPS forecast has been revised up by 2% over the past six months

 The potential weakness comes from resources: both energy and materials were forecast three months ago to see positive growth this year

Note: Earnings momentum = 6-month % change in 12-month forward consensus forecast Source: HSBC

Cheapest level for 13 years

 Australia, on a 12-month forward PE of 12.0x, is on the cheapest multiple since 1995

 This compares with a post-2001 average of 14.9x and a 15-year average of 16.1x

 However, 10-year government bonds remaining stubbornly high at 6.0% and rising volatility somewhat weaken the valuation argument

discr IT Telco

Mate

rials

Utilities

Financials

12-month fwd PE 5-year PE mean

Financials especially cheap, energy expensive

 The only sectors trading above their five-year average PEs are energy, telecoms and materials

 Financials are the second cheapest such sector in Asia Pacific, reflecting their increased risk

 Energy, on 17.7x forward earnings, looks expensive both versus history and against peers in Asia

Small foreign buying continues

 High-frequency foreign flow data is not available for the Australian market

 We do know, however, net flows from global mutual funds, which put USD320m into Australia over the past six months

 Domestic superannuation (pension) funds continue to provide support, buying

an estimated AUD22bn of Australian equities a year

Source: EPFR, HSBC

Attractive – despite the cycle

In our view, international investors have not yet

understood how big a change new president Lee

Myung-bak could bring to Korea After 10 years

of populist left-of-centre rule, we believe Lee will

pursue an agenda of privatisation, deregulation

(for example of the real estate market),

liberalisation, and encouragement of foreign

capital inflows True, some of his policies are a

little suspect from the market’s point-of-view: for

example, his plan to build a canal from one end of

the country to another, and his protective attitude

towards the chaebol

But if his Grand National Party is able to win a

majority in the parliamentary election on 9 April,

not only will it make it much easier for him to

implement these policies, but it will allow him to speak more openly on policies he favours, but that might have been tricky to talk about before the election That, we think, could be the trigger for international investors to wake up to how potentially big a change Korea might see

Of course, Korea will face significant cyclical headwinds this year We forecast that real GDP growth will slow to 4.2% (the lowest since 2003),

as exports grow only 8% Private consumption is also likely to weaken a little Analysts’ forecasts for EPS growth of 27% for the IT sector and 35%

for consumer discretionary (which comprises mainly autos) seem too optimistic – although the 15% forecast for the market as a whole probably won’t be revised down much

Korea (overweight)

 Yes, perhaps Korea is too cyclical for the current environment

 But it is also cheap and has a strong domestic investor base

 …and, if the GNP wins April’s election, some interesting policies

Key financial and economic forecasts

Return (%, USD) MSCI Korea KOSPI Economic forecast 2008 2009 Valuations 2008 2009

1Q08 sector performance (%) Absolute Relative Earnings (%)

Source: HSBC, I/B/E/S

On the other hand, the new government seems

determined to give the economy a boost and, in

conjunction with structural reforms, this should

produce a pick-up in investment It may also be

able to strong-hand the Bank of Korea into

modest rate cuts this year – we forecast 50bps

Net inflows into Korean equity-related investment trusts

Also offsetting the cyclical worries are: (1) the

fact that, with a PE of 10.1x, Korea is the cheapest

market in the region, thereby limiting downside

risk, and (2) continuing buying from domestic

retail investors who, despite the market turmoil,

have put KRW17.3trn into equity-related

investment trusts this year to date

Inflection points

Result of parliamentary election, April 9

How quickly can President Lee Myung-bak start to implement policies

Does domestic demand hold up in face of slowing exports

Source: HSBC

Sectors and stocks Given our worries on the cyclical front, our main overweights continue to be quite defensive We

like healthcare, which has both good growth

prospects (as the population ages and Korean drugs companies develop more of their own molecules) and defensiveness There are a number

of interesting consumer staples companies,

which are expanding and should continue to make good profits even if consumption slows

Other overweights include materials, where we

see steel companies doing well this year as prices rise further (with infrastructure spending giving a

possible boost), and utilities, which are classically

defensive and should benefit from the rebound in

the KRW, which we expect Within industrials,

we also like construction companies, which are major beneficiaries of government policy changes

We are underweight most export-sensitive,

cyclical sectors such as consumer discretionary and technology

Major changes this quarter include cutting our

overweight position in financials to underweight

Banks’ earnings are starting to decline and the dependence on debenture issues for funding is risky in the current credit-crunch environment

We have also lowered energy from overweight to

neutral We believe that refining margins will remain strong, but the sector is likely to remain weak as investors worry about them declining

Sectors weightings and stock screening

Cons Disc Underweight Kia Motors, Lotte Shopping Co Ltd

Cons Staples Overweight Shinsegae Department Store, LG Household & Health Care, KT& G

Energy Neutral S-Oil, GS Holdings Corp

Financials Underweight Shinhan FGL, Industrial Bank of Korea, Pusan Bank

Healthcare Overweight

Industrials Neutral

Technology Underweight LG Philips LCD, Samsung Techwin

Materials Overweight POSCO

Telecoms Neutral

Utilities Overweight

(Stocks shown are those with market cap above USD1bn, where HSBC’s analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current

stock price Up to three stocks are shown in each category for each sector For latest prices of covered stocks see Appendix 1.) Source: HSBC

Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08

Cyclicals Defensive Energy

Financials IT Telecoms

Main index

Energy sector the worst performer

 MSCI Korea has fallen by 12% over the past three months, underperforming Asia ex Japan by 2ppts

 Energy was the worst performing sector in Q1 falling 43%

 Although all sectors fell in Q1, IT was the best performer, falling only 11%

Sharply falling forecasts

 Korean economic forecasts have been sharply revised down over the past few months

 The consensus now expects 4.6% real GDP growth for 2008, compared to 5.0% at the end of last year

 HSBC’s economists, with a 4.2% forecast for 2008, are even more pessimistic than this

Source: Consensus Economics, HSBC

KR Econ Performance Index MSCI KR (RHS)

…but fundamentals remain strong

 Despite economists’ concerns about the outlook, recent Korean economic data remains firm

 February exports grew 19% y-o-y, and both consumer and business sentiment remain well above 100

 Our Economic Performance Index (see chart) has improved by 9% over the past month, and the Surprise Index by 50%

Source: Bloomberg, MSCI, HSBC

Decent growth forecast

 Korean EPS is forecast to grow by 14.6% this year, after 5.6% growth last year

 Strongest growth is expected from energy (48%) and consumer discretionary (35%)

 Telecoms (-7%) and financials (-0.5%) are expected to see earnings decline

Source: I/B/E/S, HSBC