By Garry Evans
What kind of bear?
Asia’s bear market is likely to be mild, not vicious
Macro
Equity Strategy
Q2 2008
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 in
the 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 in
2003-7. 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 for
political change, and Malaysia which is classically defensive and where political
worries are overdone. For sectors, we stick to structural growth stories such as
consumer-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

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.
Main contributors
Akane Nishizaki*

Strategist
+813 5203 3943

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

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.
Garry Evans*
Strategist
+852 2996 6916

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

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.
Q2 2008Equity StrategyWhat kind of bear?



Equity Strategy
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Second Quarter 2008
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Country weights and key reasons for our view
Neutral

HSBC
recommended
weight

Last
Quarter
Rel perf
last
3 mths
Key pluses Key minuses
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
NZ 0.3% 0.0% UNDER UNDER 3.0% Few interesting investible stocks
Philippines 0.3% 0.0% UNDER UNDER -9.4% Too risky for the current environment
Pakistan 0.1% 0.0% UNDER UNDER 29.2% Political situation still unstable
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
Neutral
HSBC
recommended
weight
Last
Quarter *
Rel perf
last
3 mnths
Key pluses Key minuses
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))


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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
To From Reason
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


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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
Index
Current level
3/27/2008
Target end
2008
Upside
Old end-
2008 target
Target end
2009
Upside vs
2008
Old end-
2009 target
Japan TPX Index 1,226 1,150 -6.2% 1,500 1,250 8.7% 1,600
Australia AS51 Index 5,372 5,500 2.4% 6,800 6,000 9.1% 7,500
China MXCN Index 64 75 17.4% 105 85 13.3% 120
Korea KOSPI Index 1,676 1,900 13.3% 2,200 2,200 15.8% 2,500
Taiwan TWSE Index 8,606 9,000 4.6% 8,200 10,000 11.1% 9,000
HK HSI Index 22,664 26,000 14.7% 31,000 29,000 11.5% 35,000
India Sensex Index 16,016 17,500 9.3% 23,000 21,000 20.0% 28,000
Singapore FSSTI Index 3,025 3,500 15.7% 4,000 4,000 14.3% 4,400
Malaysia KLCI Index 1,254 1,380 10.0% 1,500 1,500 8.7% 1,650
Thailand SET Index 823 950 15.4% 1,000 1,050 10.5% 1,200
Indonesia JCI Index 2,451 2,200 -10.3% 2,600 2,500 13.6% 2,900
Vietnam VNINDEX Index 509 600 17.9% 1,100 750 25.0% 1,300
MSCI Asia ex Japan MXFEJ Index 491 540 10.0% 570 613 13.6% 647
MSCI Asia Pacific MXAP Index 140 142 1.7% 177 158 10.7% 195

Source: HSBC


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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

Financials

Industrials

IT
Cons
Discretionary Materials Telecoms Energy
Cons
Staples

Utilities
Health
Care
UNDER UNDER UNDER UNDER NEUTRAL OVER NEUTRAL OVER NEUTRAL OVER
Japan UNDER UNDER UNDER UNDER OVER OVER OVER
Australia UNDER UNDER UNDER UNDER OVER
China OVER UNDER UNDER UNDER OVER OVER OVER
Korea OVER UNDER UNDER OVER OVER OVER OVER OVER
Taiwan UNDER UNDER UNDER UNDER OVER OVER OVER
HK NEUTRAL OVER UNDER UNDER OVER UNDER
India NEUTRAL UNDER OVER UNDER OVER OVER OVER UNDER
Singapore OVER UNDER OVER OVER
Malaysia OVER OVER OVER OVER

Thailand OVER OVER OVER OVER OVER OVER
Indonesia UNDER OVER
NZ UNDER
Philippines UNDER
Pakistan UNDER
Vietnam OFF-BMK OVER
Source: HSBC



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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.


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HSBC’s top 10 high-conviction buy ideas

Code Name
Country/
region
Sector HSBC rating
Upside
to target
price (%)
Price
(local curr)
1 Apr
Market
cap
(USDm)
941 HK CHINA MOBILE LTD CH Telecoms Overweight (V) 25.7 117.70 (HKD) 302,769
3328 HK BANK OF COMMUNICATIONS CO-H CH Financials Overweight (V) 22.0 9.26 (HKD) 27,422
825 HK NEW WORLD DEPT STORE CHINA CH Consumer Overweight (V) 39.1 8.84 (HKD) 1,914
BHEL IN BHARAT HEAVY ELECTRICALS IN Industrials Overweight (V) 71.8 1,892.20 (INR) 23,087
MSIL IN MARUTI SUZUKI INDIA LTD IN Autos Overweight 50.2 815.75 (INR) 5,874
000640 KS DONG-A PHARMACEUTICAL CO LTD KR Healthcare Overweight 19.4 107,000.00 (KRW) 1,115
033780 KS KT&G CORP KR Consumer Overweight 25.2 77,000.00 (KRW) 11,015
005490 KS POSCO KR Materials Overweight 49.6 468,000.00 (KRW) 41,471
ST SP SINGAPORE TELECOMMUNICATIONS SG Telecoms Overweight 14.4 3.96 (SGD) 45,738
1303 TT NANYA PLASTICS TW Materials Overweight 46.3 73.80 (TWD) 18,578
Source: HSBC


Top sell ideas
Code Name
Country/
region

Sector HSBC rating
Upside
to target
price (%)
Price
(local curr)
1 Apr
Market
cap
(USDm)
NACL IN NATIONAL ALUMINIUM CO LTD IN Metals Underweight (V) -22.5 462.10 (INR) 7416
2618 TT EVA AIRWAYS CORP TW Transportation Underweight -20.9 18.80 (TWD) 2,429
Source: HSBC





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Investment strategy 7
What kind of bear? 7
Earnings 18
No big downward revision yet 18
Valuation 20

Massive derating 20
Supply and Demand 22
Massive foreign selling 22
Politics and risk 24
Attention shifts to India, Japan 24
Country profiles 27
Japan (underweight) 28
Gloomy and depressing 28
Australia (underweight) 32
Higher rates, lower growth 32
Korea (overweight) 36
Attractive – despite the cycle 36
China (overweight) 40
Long-term value emerges 40
Taiwan (underweight) 44
Excessive expectations 44
Hong Kong (neutral) 48
Negative real rates to help 48
India (neutral) 52
Hold on 52
ASEAN (overweight) 56
Interesting opportunities 56
Sectors & Stocks 64
Focus on quality 64
Quantitative scorecards 68
Top stock picks 72
What to buy – and what not 72
Appendix 86
Disclosure appendix 88
Disclaimer 92


Contents


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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
80
100
120
140
160
180
200
Mar-03
Jun-03
Sep-03
Dec-03
Mar-04
Jun-04
Sep-04
Dec-04
Mar-05
Jun-05
Sep-05
Dec-05
Mar-06
Jun-06
Sep-06

Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Asia ex Japan rel to MSCI World Asia Pac rel to MSCI World
Source: HSBC, Bloomberg


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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
leverage) underperformed.
2. Prospective PE and absolute EPS for MSCI Asia ex-Japan
0
10
20
30
40
50
02 03 04 05 06 07 08
0
5
10
15
20
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
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Av erage

Source: HSBC, Bloomberg

This does not necessarily mean, however, that
equity returns will be disastrous. We do not
believe the most pessimistic scenarios which
suggest that credit-related losses will reach 5% or
10% of US GDP (i.e. USD600bn-1.3trn),
triggering the worst recession since World War

Two. The US authorities have reacted remarkably
quickly to address the problems. We expect, for
example, that the US Fed will cut rates to 1% by
early 2009. Moreover, HSBC’s economists look
for US growth to slow only moderately to 1.5%
this year and 1.2% next – a double-dip “W-
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
2009, down from 9.1% in 2007 (see HSBC’s Q2
Asian Economics Quarter: The gathering storm
for details).


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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
-50 -25 0 25 50 75 100 125 150
04 06
Jul 07 Oct 07

Source: HSBC, Bloomberg

By contrast, this time the market bottom (to date)
came as much as 100 days after the top, there
have already been three clear down-legs as well as
two sharp rallies. The pattern is starting to look
much more like the three bear markets that have
taken place in Asia ex Japan (see Chart 5) since
the region became open to international investors:
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


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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
150
250
350
450
550
650
2000 2001 2002 2003 2004 2005 2006 2007 2008
50
100
150

200
250
300
350
400
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
1990
1993
1996
1999
2002
2005
2008
-60%
-40%
-20%
0%
20%
40%
60%
80%
ISM Manufacturing (LHS) MXFEJ y /y

Source: HSBC, Bloomberg

 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


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sterilising currency intervention as US rates
fall below those in Asia.
8. Average CPI inflation in Asia ex Japan
-2
0
2
4
6
8
10
12

14
97 98 99 00 01 02 03 04 05 06 07 08

Source: HSBC, Bloomberg

 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
2000
2001
2002
2003
2004
2005
2006
2007
2008
$ bn
Japan Asia ex -Japan

Source: HSBC, Bloomberg

It is hard to imagine that these worries will
disappear overnight. A period of consolidation is
needed before investors will be willing
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).


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10. Total daily turnover (USDbn) of Asia ex Japan markets
0
20
40
60

80
100
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
AEJ

Source: HSBC, Bloomberg

 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
Jan-00
Apr-00
Jul-00
Oct-00
Jan-01
Apr-01
Jul-01
Oct-01
Top
Bottom
10.2%
13.9%
10.5%
10.8%
15.3%

Source: HSBC, Bloomberg


 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



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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
March 2003.
12. Previous bear markets in MSCI Asia ex Japan
0

100
200
300
400
500
600
700
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: HSBC, Bloomberg

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.


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13. Consensus forecasts of Asia ex Japan EPS by year
20
25
30
35
40
04 05 06 07 08
'05
'08
'07
'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
2% 4% 6% 8% 10% 12% 14%
+20%
-10%
+10%
0%
-20%
Jan
Ap
r
A
B
C
PE (x)
EPS grow th

Source: HSBC

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.


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 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
-60
-40
-20
0

20
40
60
-60 -40 -20 0 20 40 60
EPSg
PEg

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 time-
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
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


16

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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
Politics
Sensitivity to
US/global growth
Valuation
Structural
worries
Long-term
story
TOTAL Rank
Weight 20% 10% 20% 10% 15% 15% 10% 100%

JP 1 -2 -3 -2 0 1 -1 -0.75 13
AU -2 -1 0 -1 1 1 1 -0.20 10
KR 0 -1 2 -1 1 0 1 0.45 4
CH -1 0 1 1 1 0 3 0.55 3
TW -1 -2 1 -3 1 1 1 -0.10 8
HK 2 0 0 -1 -1 1 1 0.40 5
IN 0 1 -1 3 -1 -1 2 0.10 6
SG 1 1 0 1 2 2 1 1.10 2
MY -1 1 -1 2 1 -1 1 0.00 7
ID -2 1 1 2 -1 -1 1 -0.10 9
TH 1 1 3 0 1 0 1 1.15 1
PH -1 1 -1 0 0 -1 1 -0.35 11
VN -2 -1 0 -1 0 -2 2 -0.70 12
Source: HSBC




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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 12-
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%
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


19
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1. 12-month forward EPS growth vs MSCI Asia ex Japan 2. Consensus forecasts for EPS growth
0
10
20

30
40
50
1994 1996 1998 2000 2002 2004 2006 2008
%
-60%
-40%
-20%
0%
20%
40%
60%
80%
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
M alaysia 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

3. Earnings momentum – Asia ex Japan 4. Upgrades as % of total earnings revisions – Asia Pacific
-30
-20
-10
0
10
20
30
40
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Asia ex-Japan



20
25
30
35
40
45
50
55
60
65
70
2000
2001
2002
2003
2004
2005
2006
2007
2008
Upgrades as % ot total

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

5. Revisions to 2008 EPS forecasts by country 6. Revisions to 2008 EPS forecasts for Asia Pacific sectors
Country Vs 3 Months ago Rank Vs 6 Months ago Ra n k
ID 7.5% 1 9.4% 2
CN 2.4% 2 9.9% 1

IN 1.1% 3 4.2% 4
TH -0.2% 4 0.6% 6
HK -0.3% 5 4.9% 3
MY -0.8% 6 1.8% 5
PH -1.2% 7 -3.9% 7
SG -3.0% 8 -3.9% 8
KR -3.5% 9 -5.3% 9
AU -5.1% 10 -5.7% 10
TW -7.9% 11 -8.2% 12
JP -11.9% 12 -7.2% 11
AEJ -1.1% 0.8%
AP 2.2% 3.6%


Sector Vs 3 M onths ago Rank Vs 6 M onths ago Rank
Indus trials
5.7%
1
9.1%
3
Cons. stap
4.9%
2
6.1%
5
Health c are
4.8%
3
7.7%
4

Energy
4.7%
4
9.3%
2
Telco
3.6%
5
10 .2%
1
Cons. discr
3.4%
6
4.4%
6
Financials
1.4%
7
2.5%
7
Mater ials
0.2%
8
1.3%
8
IT
-1.7%
9
-1.5%
9

U til it ie s
-4.3%
10
-10.8%
10
Asia Pac
2.2% 3.6%

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



20
Equity Strategy
Asia Pacific
Second Quarter 2008
ab
c

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 10-
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,
we lowered 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


21
Equity Strategy
Asia Pacific
Second Quarter 2008
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1. 12-month forward PE – Asia ex Japan 2. Current forward PE versus historical averages
8

10
12
14
16
18
20
2001 2002 2003 2004 2005 2006 2007 2008
Forward PE - Asia ex-Japan


PER now Average 2001- % diffe rence Average 1993- % differe nce
Ch i n a 12 . 4 1 3. 0 - 5% 13. 3 - 7 %
HK 15.5 16.1 -4% 14.8 5%
In di a 15 . 6 1 3. 8 1 3% 1 3. 6 15 %
Indonesia 12.5 9.0 39% 12.9 -3%
Korea 10.5 8.8 19% 11.3 -7%
Mal ay s i a 12 . 9 1 4. 3 - 1 0% 1 6. 4 - 21 %
Philippines 12.1 14.3 -15% 15.0 -20%
Singapore 12.5 15.2 -18% 16.7 -25%
T aiw an 12 . 2 1 3. 6 - 1 0% 18. 4 - 34 %
Thailand 10.7 10.6 1% 21.6 -50%
J a pa n 12 . 2 1 9. 6 - 3 7% 32. 4 - 62 %
Australia 12.0 14.9 -19% 15.2 -21%
Asia e x- Japan 12.4 12.4 1% 14.7 -15%
Asia Pacific 12.5 16.4 -23% 26.4 -53%

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

3. 2008 PE versus average EPS growth 2008-9 4. PB versus ROE/COE
AP

AEJ
TH
TW
SG
PH
MY
KR
JP
ID
IN
HK
CH
AU
8
10
12
14
16
18
20
0 10203040
EPG growth 2007-9
Fwd PE
PEG>1
PEG<1


TH
AU
JP

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
0.81.31.82.32.83.3
PBR
ROE/CO

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



5. Dividend discount model
SG AU MY CH IN PH TW HK JP VN TH ID
Inputs
DPS YR1 62.3 53.4 21.0 1.2 7.5 22.2 14.9 320.3 20.1 13.0 10.6 71.2
EPS YR1 129.1 85.4 34.1 4.5 39.0 47.0 25.9 659.2 61.8 40.7 30.9 258.1

EPS YR2 143.5 93.0 37.5 5.1 48.7 54.2 28.0 744.6 67.4 48.9 33.1 293.7
Growth in stage 2 (%) 9.0 7.0 9.0 13.0 12.0 10.0 6.0 6.0 6.0 15.0 10.0 15.0
No of years of excess growth 10 10 10 12 15 10 10 10 10 20 10 15
Perpetual growth rate (%) 6 6 6 66666466 6
Payout ratio now (%) 48.3 62.5 61.5 26.7 19.2 47.2 57.7 48.6 32.5 32.0 34.4 27.6
Payout ratio at end stage 2 (%) 50 50 50 40 40 45 50 50 40 40 45 45
COE (%) 9.0 9.6 10.0 11.0 10.5 11.0 9.5 9.0 8.0 15.0 12.5 15.0
Result

MSCI index now 1,746 1,067 466 63 655 579 341 11,069 785 505 346 3,493
Fair value 2,751 1,336 571 71 728 634 368 11,073 767 489 265 2,570
Under/over valued (%) -36.5 -20.2 -18.4 -11.3 -9.9 -8.6 -7.6 0.0 2.3 3.2 30.9 35.9
Source: HSBC


22
Equity Strategy
Asia Pacific
Second Quarter 2008
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c

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


23
Equity Strategy
Asia Pacific
Second Quarter 2008

ab
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1. Cumulative net buying by foreign investors since 2000 2. Foreign net buying by markets 2007
-50
0
50
100
150
200
250
300
350
400
2000
2001
2002
2003
2004
2005
2006
2007
2008
$ bn
Japan Asia ex-Japan


Foreign investors' net investment in Asian equity markets
($bn) JP TW KR TH IN ID
Mar-07 -2.2 -3.1 -1.1 0.0 0.3 0.3

Apr-07 12.2 2.4 2.9 0.4 1.3 0.7
May-07 6.2 1.3 0.2 0.7 1.1 0.3
Jun-07 13.8 5.5 -3.8 0.9 1.8 0.4
Jul-07 6.6 -0.3 -5.3 1.0 4.6 0.4
Aug-07 -8.9 -5.2 -9.3 -1.1 -1.8 0.6
Sep-07 -4.3 1.9 -2.1 0.1 4.7 0.3
Oct-07 2.0 1.6 -2.3 0.4 4.4 0.1
Nov-07 -3.1 -4.6 -7.3 -1.2 -1.2 0.1
Dec-07 -2.9 0.8 -2.6 -0.5 1.2 0.0
2007 43.5 2.1 -29.4 1.6 17.8 3.2
Jan-08 -3.3 -1.0 -9.0 -1.2 -4.4 0.1
Feb-08 -3.5 3.1 -2.1 1.0 1.2 0.2
Mar-08 -12.2 -1.7 -3.9 -0.4 -0.7 -0.4
2008 YTD -19.0 0.4 -15.0 -0.6 -3.9 -0.1

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
AU 15.5 30.8 23.3 1.3 -75%
CH 28.5 69.0 53.1 4.9 -58%
HK 10.1 20.2 20.7 0.1 -98%
IN 10.1 12.2 24.3 5.1 -5%
JP 43.9 56.6 19.5 2.1 -65%
KR 15.8 11.3 10.1 1.3 -52%
MY 1.3 1.1 3.1 0.2 -75%
SG 3.7 5.2 6.1 0.2 -84%
TH 1.2 2.9 0.6 0.0 -86%
TW 15.8 11.3 10.1 1.3 -44%
AEJ 86.0 132.1 158.0 13.6 -93%

AP 145.3 219.6 177.6 15.7 -85%


-200
-100
0
100
200
300
2001
2002
2003
2004
2005
2006
2007
2008
(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
-2,000
3,000
8,000
13,000
18,000
2001
2002

2003
2004
2005
2006
2007
2008
Won Bln
Net inflow into equity related investment trust


-400
-200
0
200
400
600
800
1000
2001
2002
2003
2004
2005
2006
2007
2008
INR bn
Mutual Funds Net Flow

Source: CEIC, HSBC Source: CEIC, HSBC