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- Macro
Equity Strategy
Q2 2008
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 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.
By Garry Evans
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
- Equity Strategy
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Second Quarter 2008
Country weights and key reasons for our view
Neutral HSBC Last Rel perf Key pluses Key minuses
recommended Quarter last
weight 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 Investor sentiment badly dented
Economy likely to continue to grow robustly this year
Long-term growth story intact
Korea 8.0% 9.5% OVER OVER -10.2% Lee Myung-bak’s policy programme a big positive Facing strong cyclical headwinds
Cheapest market in Asia, on PE of 10x
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 Downside risk to consensus earnings forecast
Long-term structural growth story still exciting 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 Exports are very high percentage of GDP
Cheap, with PE down to 12x
Defensive, with range of blue-chip growth companies
Malaysia 1.5% 2.5% OVER UNDER 1.5% Political worries after March’s election are overstated Political concerns may linger if PM resigns
Valuations now reasonable Economy – but not listed stocks – rather cyclical
Thailand 1.0% 2.5% OVER OVER 19.8% New government to boost infrastructure spending Political instability not over
Cheap: PE 11x
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 Last Rel perf Key pluses Key minuses
recommended Quarter * last
weight 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 Regulatory risk
Valuations back to reasonable levels
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 Valuations quite expensive
Beneficiary of the Asian consumer story
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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Second Quarter 2008
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.
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’
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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- Equity Strategy
Asia Pacific abc
Second Quarter 2008
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 Target end Upside Old end- Target end Upside vs Old end-
3/27/2008 2008 2008 target 2009 2008 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
2
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Second Quarter 2008
Key country and sector recommended weights
Cons Cons Health
Financials Industrials IT Discretionary Materials Telecoms Energy Staples Utilities 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
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
3
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Second Quarter 2008
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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Second Quarter 2008
HSBC’s top 10 high-conviction buy ideas
Code Name Country/ Sector HSBC rating Upside Price Market
region to target (local curr) cap
price (%) 1 Apr (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/ Sector HSBC rating Upside Price Market
region to target (local curr) cap
price (%) 1 Apr (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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Second Quarter 2008
Contents
Investment strategy 7 Taiwan (underweight) 44
What kind of bear? 7 Excessive expectations 44
Earnings 18 Hong Kong (neutral) 48
No big downward revision yet 18 Negative real rates to help 48
Valuation 20 India (neutral) 52
Massive derating 20 Hold on 52
Supply and Demand 22 ASEAN (overweight) 56
Massive foreign selling 22 Interesting opportunities 56
Politics and risk 24 Sectors & Stocks 64
Attention shifts to India, Japan 24 Focus on quality 64
Quantitative scorecards 68
Country profiles 27
Top stock picks 72
Japan (underweight) 28 What to buy – and what not 72
Gloomy and depressing 28
Appendix 86
Australia (underweight) 32
Higher rates, lower growth 32
Disclosure appendix 88
Korea (overweight) 36 Disclaimer 92
Attractive – despite the cycle 36
China (overweight) 40
Long-term value emerges 40
6
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Second Quarter 2008
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
What kind of bear? came in in line with expectations at 21%; and
forecasts for 2008 earnings growth have stayed
“In theory, there is no difference between theory
fairly steady. Yet, MSCI Asia ex Japan fell 13%
and practice. In practice, there is.” Yogi Berra
in dollar terms over the quarter (15% in local
The first quarter was a peculiar one for Asian currency terms) and the forward PE ratio derated
stocks. Economic fundamentals continued to look from 15.6x at the end of last year to 12.1x at the
strong (with average exports, for example, still lowest point in March.
growing 12% y-o-y); earnings results for 2007
1. MSCI Asia-Pacific and MSCI Asia ex Japan (in dollars) vs MSCI World
200
Asia ex Japan rel to MSCI World Asia Pac rel to MSCI World
180
160
140
120
100
80
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Source: HSBC, Bloomberg
7
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Second Quarter 2008
The theory of economic decoupling therefore about how much the US (and, by extension, the
looks to have some validity but, in practice, global global) economy will slow, and about how long
risk aversion has meant that international the side-effects of the dysfunctional credit
investors have pulled significant amounts of markets will continue and where they will emerge
money out of Asia (USD39bn in January-March next. That means that volatility (which has risen
in the eight markets that provide data – which do to 30-40% from the 10-15% level at the start of
not include China or Hong Kong). With Asia 2007, see Chart 3) will continue to be high, and
being a higher beta region than more developed the upside for the market will be, at best, limited
markets, it fell further – the US was down 10% compared to the past few years.
and Europe 11%.
3. Average 10-day historic volatility of Asia Pacific indexes
After a period of such shocks, it seems highly 60
Av erage
unlikely, in our view, that markets will return to 50
normality smoothly. We probably have to accept
40
that the bull market which began in April 2003
30
(or, some might argue, September 2001) is over.
20
Through most of this period, economic growth in
Asia accelerated, earnings rose steadily, and 10
valuation multiples expanded (see Chart 2). Stock 0
market corrections were treated as opportunities 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
to buy. Bad news was generally shrugged off.
Source: HSBC, Bloomberg
International investors increased allocations to
emerging markets; domestic retail investors in This does not necessarily mean, however, that
many countries discovered the joys of equity equity returns will be disastrous. We do not
investment for the first time. Investors were happy believe the most pessimistic scenarios which
to take more risk: fund managers who were too suggest that credit-related losses will reach 5% or
cautious (with too much cash or too little 10% of US GDP (i.e. USD600bn-1.3trn),
leverage) underperformed. triggering the worst recession since World War
2. Prospective PE and absolute EPS for MSCI Asia ex-Japan Two. The US authorities have reacted remarkably
quickly to address the problems. We expect, for
50 20
example, that the US Fed will cut rates to 1% by
40 early 2009. Moreover, HSBC’s economists look
15
30 for US growth to slow only moderately to 1.5%
10 this year and 1.2% next – a double-dip “W-
20
shaped” pattern – but to avoid a technical
5
10 recession. In Asia, growth is likely to slip a little
EPS PE (RHS)
0 0 too but nonetheless remain impressive: we
02 03 04 05 06 07 08 forecast overall real GDP growth for Asia ex
Japan to slow to 7.8% this year and 7.8% again in
Source: HSBC, Datastream, IBES
2009, down from 9.1% in 2007 (see HSBC’s Q2
Asian Economics Quarter: The gathering storm
That world is over. For the next few quarters, fear
for details).
will predominate over greed. Investors will worry
8
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Second Quarter 2008
But bear markets – for that is probably what we 4. Corrections 2004-7
are now in – have their own dynamic. They are 120
characterised by sharp rallies, as investors try to 110
pick the bottom, followed by scary plunges.
100
Sector and style performance behave rather
90
differently to a bull market. Bear markets tend to
drag on for longer than most people expect. But 80
they don’t always produce dramatic declines in 70
stock indexes. We will argue below that this is -50 -25 0 25 50 75 100 125 150
04 06
likely to be a rather mild bear market for Asia. Jul 07 Oct 07
And bear markets do create opportunities too:
Source: HSBC, Bloomberg
investors can make money by trading in and out
of the dips and rallies, or by focusing on stocks By contrast, this time the market bottom (to date)
that are attractive from a long-term perspective came as much as 100 days after the top, there
but which get sucked down with the overall have already been three clear down-legs as well as
market decline to become cheap. two sharp rallies. The pattern is starting to look
Is it a bear? much more like the three bear markets that have
taken place in Asia ex Japan (see Chart 5) since
There is no clear definition of what differentiates
the region became open to international investors:
a market correction from a bear market.
1994, 1997 and 2000. On these three occasions, it
Strategists in the US usually define a correction as
took 274, 304 and 448 trading days for the index
a drop in the index of 10-20%, and a bear market
to bottom. It fell in total 33%, 69% and 56% on
as a drop of more than 20% (on this basis, the
these three occasions respectively. It is important
S&P500, which has fallen 18.6% from peak to
then, if we accept that the current market is a bear,
trough, is still only in correction territory).
to work out what sort of bear. We will come back
Since Asia is a more volatile market (volatility to this issue later.
over the past 10 years has been 1.44x that of the
5. Bear markets in MSCI Asia ex Japan
US), we would adjust those definitions to say that
a correction is a 14% decline, and a bear market a 110
100
decline of more than 29%. On that basis, MSCI 90
Asia ex Japan just dipped into bear market 80
70
territory in March – at its low point it was down
60
29.6%. 50
40
The pattern of the market over the past five 30
months, since its peak on October 29, has looked -50 0 50 100 150 200 250 300 350 400 450 500
more like a bear market than a correction too. 94 97 00 07
Chart 4 shows the three corrections (using our
Source: HSBC, Bloomberg
definition above) in the 2003-7 bull market (with
the market peak shown as 100 at Day 0); the
We are not chartists and so don’t want to rely just
recent market movement shown in red. In each of
on what index trading patterns tell us. But recent
the three corrections, the market bottomed within
market fundamental characteristics also point to
25 days and had only one leg down.
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Second Quarter 2008
this being a longer, more serious downturn than have not (yet) fallen sharply. The
just an intra bull market correction: manufacturing ISM index, for example,
remained at 48.6 in March, only just below
Measures of risk aversion have continued to
the cut-off line of 50 (Chart 7). It seems
deteriorate, despite the efforts of the Fed to
inevitable that this will fall to at least 45 over
inject liquidity and rescue insolvent
the coming months. Although the correlation
investment banks. The average spread on
of Asian equity markets with the ISM has
Asian corporate bonds has risen to 350bp
weakened somewhat recently (decoupling?),
from 240bp at the start of the year (Chart 6).
it is hard to imagine that a further fall in the
Equities have largely moved in line with this
ISM would not worry investors in Asian
measure of risk, except for a short period in
stocks.
Q4 last year. Our credit strategists argue that
the worst may be over for credit and that 7. US ISM Manufacturing index vs MSCI Asia ex Japan
spreads may peak this quarter, which could 65 80%
provide support for equities. Indeed, the 60%
60
spread narrowed by about 20bps in the last 40%
55 20%
week of March after JP Morgan bought Bear
50 0%
Sterns. We believe, though, that the full
-20%
ramifications of the credit crunch have not yet 45
-40%
appeared: we expect new problems in the 40 -60%
1990
1993
1996
1999
2002
2005
2008
areas of credit default swaps and private
equity, more write-offs from financial ISM Manufacturing (LHS) MXFEJ y /y
institutions, and the first signs of trouble from
Source: HSBC, Bloomberg
corporate borrowers struggling to raise funds.
6. Asian dollar bond spread vs MSCI Asia ex Japan Monetary policy will be complicated by
inflation. Although the Fed is aggressively
650 50
100
cutting rates, in Asia Pacific, some central
550
150 banks are still focused on combating inflation:
450 200 Australia and Taiwan both raised rates in
350 250 March; China, Vietnam, and Indonesia
300 remain in tightening mode. With average
250
350
Asian inflation (ex Japan) having risen to
150 400
6.3% in February (see Chart 8), central bank
2000 2001 2002 2003 2004 2005 2006 2007 2008
decision-making is not straightforward. And
MSCI Asia ex J ADBI spread (RHS, inv erse)
this environment is throwing up other
Source: HSBC, Bloomberg
problems: a shortage of rice throughout the
region, government controls on retail prices
Global economic data is likely to weaken
of essential goods which could negatively
further. Our economists expect real GDP
affect the profitability of producers, extreme
growth in the US to drop to -0.5% q-o-q
currency movements (for example, in Korea
annualised in Q2, after 0.5% in Q1 and 0.6%
or Vietnam in March) as foreigners chase
in Q4 2007. It is one surprising factor in the
high-yielding instruments in appreciating
past few months that US cyclical indicators
currencies, and increasing difficulties in
10
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
sterilising currency intervention as US rates 9. Cumulative net flows into Asian equities
fall below those in Asia. 350
300 Japan Asia ex -Japan
8. Average CPI inflation in Asia ex Japan
250
14 200
$ bn
12 150
10 100
50
8
0
6
-50
4
2000
2001
2002
2003
2004
2005
2006
2007
2008
2
0 Source: HSBC, Bloomberg
-2 97 98 99 00 01 02 03 04 05 06 07 08
It is hard to imagine that these worries will
Source: HSBC, Bloomberg
disappear overnight. A period of consolidation is
needed before investors will be willing
Foreign flows. Risk aversion means that an
aggressively to take risk again. In a sense, over
unprecedented amount of capital has been
the coming months bad news will be good news
withdrawn from Asia over the past few
because it will mean the market is getting closer
months (Chart 9). This year so far, foreign
to absorbing all that the global environment has to
investors have sold USD20bn of Japanese
throw at it. Clear signs of a US recession, further
stocks, USD14bn of Korean ones and
large write-offs by banks or news of new distress
USD3bn in India. Only Taiwan and Vietnam
in the credit market would, paradoxically, be
have escaped the sell-off. Emerging Portfolio
welcome because they would bring us nearer to
Fund Research reports that Asia ex Japan
the end of the worst.
mutual funds globally saw outflows of
USD12bn in Q1 (and Japan funds outflows of What do bears look like?
USD6bn). China and Greater China funds, in Bear markets typically go through six phases:
particular, saw outflows of USD5.4bn. After
that degree of selling, past experience is that Denial. Investors remain euphoric after a long
it takes around six months before retail run-up and treat the market decline as a
investors have enough confidence again to buying opportunity. This happened in
start to put their money back into the market. November and December last year, when
Mutual funds are unlikely to be significant equity markets in Asia rebounded despite
buyers of Asian equities for a while yet. By worsening credit market conditions.
contrast, money market funds saw a Inaction. Investors become confused and
remarkable USD141bn of inflows during the professional fund managers, in particular, sit
quarter. 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).
11
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
10. Total daily turnover (USDbn) of Asia ex Japan markets 11. Rallies in the 2000-1 bear market
100 350 Top
AEJ
80 10.2%
300
60
250 13.9% 10.5%
40
10.8%
200
20 15.3%
Bottom
0 150
Oct-06
Oct-07
Oct-00
Oct-01
Jan-06
Apr-06
Jul-06
Jan-07
Apr-07
Jul-07
Jan-08
Jan-00
Apr-00
Jul-00
Jan-01
Apr-01
Jul-01
Source: HSBC, Bloomberg Source: HSBC, Bloomberg
Panic. Investors realise they are losing Capitulation. The bottom-spotting rallies
significant amounts of money and start to peter out leaving even more investors
offload shares. This happened in the early part depressed about the long-term future of equity
of 2008, especially among retail investors in investment. Retail investors put their money
Hong Kong (who had leveraged in bank deposits, institutional funds raise their
“accumulator” positions on H-shares). It may cash holdings, strategists talk about this being
be happening now in China, India, and the worst bear market for 50 years. In our
Vietnam. This can be accompanied by an view, we haven’t reached this stage yet this
increase in volumes, as stock sales hit the time.
market.
The rebound, when it comes, often doesn’t
Bottom-spotting. At quite an early stage in require a specific catalyst, just enough people
the bear market, investors start to play the to have turned bearish and valuations to have
game of anticipating where it will bottom. If got cheap enough that the attraction of
you get this right, it can be very profitable equities reappears.
since the first leg-up of a recovery is often
But what sort of bear?
extremely sharp. The process of bottom-
spotting generally causes sharp rallies. In the The three previous bear markets in Asia were all
2000-1 bear market, for instance (see Chart very different in nature as well as in magnitude
11), there were five rallies of 10% or more. (as can be seen by referring back to Chart 5, and
This time, there have already been two well as from Chart 12 below).
(January-February and late March). 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
12
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
fairly weakly over the following year, rising pattern like 2000-3 in Asia, where stocks
30% – it did not regain its 1993 high until rebound, as they did in H1 2002, on the belief
2007! that the US economy is recovering, but that
ultimately this belief proves to be unfounded
1997: short and nasty. The 1997 bear
and they give back (most of) their gains. This
market, which began in July 1997, was
is not an unfeasible scenario for the second
caused by structural economic problems in
half of this year if the Fed’s rate cuts and
Asia (and was largely unlinked to events in
fiscal stimulus have a (temporary) positive
the rest of the world). The index fell 60% in
effect on growth.
the first six months, rallied but then had
another leg down, before bottoming in How immune Asia will be from the global
September 1998. The recovery was equally slowdown (the decoupling argument).
steep, driven by the TMT bubble – but again
To what extent further bad news emerges
did not get back to the 1997 peak until 2006.
from the dysfunctional credit market.
2000: deep and protracted. The 2000 bear
How far the Fed will be prepared to go to bail
market was the reaction to high valuations
out ailing financial institutions (including
and excess capital spending globally during
perhaps, later, hedge funds or other
the TMT bubble in 1999. It was the most
investment institutions).
protracted of the three, lasting from February
2000 to October 2001. It then had a 50% How big a psychological impact the Fed’s
rally, but almost sank back to its October actions will have on banks’ willingness to
2001 low again in both October 2002 and lend, consumers’ enthusiasm to spend, and
March 2003. corporate managers’ judgement on capex.
12. Previous bear markets in MSCI Asia ex Japan How much earnings are cut in Asia.
700
Risk aversion, not earnings recession
600
So far at least this bear market has been marked
500
purely by risk aversion, and has not been
400
accompanied by a significant slowdown in
300
earnings growth. It is true that analysts’ forecasts
200
100
for 2008 EPS growth have slipped to 8.4%, down
0
from 10.5% at the end of last year (and much
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
lower than 2007’s 20.8%). But mostly this is due
to a base effect, since last year’s results came in a
Source: HSBC, Bloomberg
little above consensus forecasts and, at this time of
the year during the results season, it can take
So what will this bear market be like? For the
analysts a while to adjust next year’s forecasts. In
moment, we think it is hard to tell. The length and
absolute terms, 2008 EPS has been cut just 3%
depth will depend on many factors:
from the peak in November. As Chart 13 shows,
How much the US economy slows and for earnings forecasts are no longer being revised up
how long. Our economists’ forecast of a W- as they were throughout 2007 – but neither are
shaped growth trajectory, would suggest a they being slashed.
13
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
13. Consensus forecasts of Asia ex Japan EPS by year PE (i.e. risk aversion) rather than by deteriorating
40 growth expectations. PE fell from 15.6x at the
'08
'07 start of the year to 12.4x; EPS growth
35 expectations have been cut from 10.5% to 8.4%.
Put another way, if PE had stayed at its end-2007
30
'06
level through the first quarter, with the earnings
25
growth the consensus now expects, we would still
'05
be looking at a market return for the year of 8% or
20 so.
04 05 06 07 08
14. Earnings growth and valuation scenarios
Source: HSBC, Datastream, IBES PE (x )
18
17 +20%
This is a very different experience to previous 16 Jan
+10%
bear markets. In 1997, for example, by November 15
14 0%
– only four months after the market had peaked –
13
analysts had already revised down their 1997 B -10%
12 Apr
estimates by 25% and 1998 estimates by 22%. 11 C
-20%
A
Within six months of the market peak, 1997 and 10
1998 forecasts had been lowered by 46% and 31% 2% 4% 6% 8% 10% 12% 14%
EPS grow th
respectively.
Source: HSBC
Analysts were almost as quick in 2000. The stock
market peaked in February 2000, and the US What possible scenarios are likely from here?
economy started to slow only in March 2001 Given the uncertainties we described above, only
(according to the NBER definition of a recession). a fool would claim to have a clear idea of the
But by July 2000, analysts had already cut their exact trajectory of the market over the next nine
forecasts for that year by 17% and for 2001 by months. We would offer three possible paths for
21%. Admittedly, 2000 came in 16% worse in the this bear market:
end than analysts believed in July, but they cannot
Scenario A: “Asian economic decoupling”.
be accused of reacting slowly.
Earnings stay robust, with analysts seeing no
Patterns for the rest of 2008 need to cut forecasts. But credit market
An aid to thinking about risk aversion versus worries and further withdrawal of foreign
earnings growth is shown in Chart 14. Here funds from Asian markets cause PEs to fall
possible index changes in 2008 (starting from 1 further. Asian stock markets fall further to
January, not from now) are shown as a factor of year-end.
(1) EPS growth on the x-axis, and (2) the year-end Scenario B: “Bouncing along the bottom”.
PE on the y-axis. The index change at each The worst of the credit crunch is over in Q2
combination of PE and EPS growth is shown by and so risk aversion eases a little, allowing
the horizontal curves. PEs to rise slightly. However, a mild
It is clear here how the decline in the first three slowdown in the US causes Asian earnings
months of the year was caused mostly by a falling expectations to be moderately revised down.
Asian stock indexes pick up modestly in H2.
14
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
Scenario C: “The nasty bear”. The credit second quarter, followed by a recovery in H2 as
crunch continues to worsen and, in the face of US economic data start to look better and credit
a sharp global slowdown, Asian earnings concerns ease, but then a further period of
growth is at risk. Analysts cut forecasts weakness next year as bank lending and risk-
aggressively. The index falls further. taking globally remain cautious and the US
economy double-dips. That is why we have index
The other feasible possibilities on the chart –
targets for end-2008for MSCI Asia Pacific only
significant upwards revisions to earnings, or a
1% above the level – although we are a little more
dramatic recovery in risk-taking which pushes PE
optimistic on MSCI Asia ex Japan, where we
up to where it was at the start of the year – seem
target a 10% rise. In terms of the scenarios above,
highly unlikely to us.
this would look like A, followed by B.)
The three previous bear markets showed very
Whatever the trajectory, we see only two ways
different patterns (Chart 15). In 1994, earnings
that investors can approach this market – both
growth was about flat but PE fell by 20%. The
very different from how one should behave in a
1997 bear market saw the nastiest combination of
bull market.
a big fall in earnings plus multiple contraction, but
in the following year PEs rebounded although Aggressively trade the rallies and dips. Get
earnings fell further. In 2000, earnings continued the timing right and this can be very
to grow robustly but valuations were dramatically profitable – although it is also hard. There
derated as the tech bubble burst; note, though, that will be individual country or sector themes
earnings did fall sharply in 2001, when PEs that will run for a few weeks. The whole
remained at their lower level. Asian market will get over-sold or
excessively cheap from time to time. (To
15. Annual return, disaggregated into change in PE and EPS
allow ourselves to help clients in these
60 98
decisions, from this Quarterly we have
40 99
03 simplified the way we present our sector and
20
01 0506 07 country recommended weightings, which will
96
PEg
0 allow us to change them quickly intra-quarter,
95
04
-20 97 94 whenever we see an attractive opportunity.)
02
-40 00
Stick to long-term growth stories – many of
-60
which will be available to pick up from time-
-60 -40 -20 0 20 40 60
EPSg to-time at bargain-basement valuations. The
old Asian stories of the past few years –
Source: HSBC, Datastream, IBES
endogenous growth, the growing middle
The result is the same class, increased infrastructure spending, more
sophisticated financial services, the
In a way, once we have agreed that the next year
development of global brands, improvements
or so will continue to be difficult, the exact type
in home-grown technology – will not go
of bear market doesn’t matter very much from the
away. But our advice would be to stick to
point-of-view of investment strategy or asset
quality: blue-chip companies, with strong
allocation. (For what it is worth, we see as the
balance-sheets, good management, a leading
most likely scenario a further leg-down in the
competitive position in their markets, and
15
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
16. Market scorecard
Monetary Earnings Politics Sensitivity to Valuation Structural Long-term TOTAL Rank
policy visibility US/global growth worries story
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
often with an attractive dividend yield. In the were the two best performing markets in Q1
country pages and the sectors and stocks (although Korea has yet to reflect what we see
section of this Quarterly, we have tried to as the much better political outlook presented
identify such themes. by its new president – but perhaps it will if his
party wins a majority in the parliamentary
As far as country allocation is concerned, we stick
election on 9 April).
to some of the themes we identified in our Q1
Preview of 2008: In the new market environment, ideally we would
want to invest in countries with all these
Implications of monetary policy. Countries
characteristics. We have tried to quantify them
with dovish central banks and only moderate
approximately in Table 16. For each category, we
inflation will look more attractive for equity
scored from -3 to +3, based on the impact on the
investors than those where the central bank is
stock market. We weighted the categories,
particularly hawkish or where inflation is
depending on how important each was in the
getting out of hand.
current environment (for example, the long-term
Endogenous growth. We prefer markets with growth story is probably less important currently
domestically driven growth, and low than the lack of structural worries).
dependence on exports.
Readers will doubtless disagree with our
A sprinkling of value. One lesson of Q1 was judgements, but this scorecard enables us to make
that when markets get too expensive (as, for a rough call on which markets now look attractive
example, India or Malaysia clearly were), (Thailand, Singapore, and China, for instance),
they can sell off dramatically on only mildly and which are better avoided (Japan, Vietnam, the
negative news (sadly, this doesn’t seem to Philippines, and Australia). We loosely based our
work in reverse with very cheap markets). country weight recommendations this quarter on
these results.
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
16
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
This page has been left blank intentionally.
17
- Equity Strategy
Asia Pacific abc
Second Quarter 2008
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
No big downward revision yet corporate tax cut (which raises net profit by about
6%) are taken into account. The forecast of 20%
Despite the recent fall in stock markets, earnings
growth in India, however, may be a little harder to
forecasts have remained remarkably resilient. EPS
achieve if economic growth slows, as we forecast,
growth in 2007 seems to have come in roughly
to only 7% and if the central bank does not cut
where analysts forecasted three months ago, 21%.
rates.
But, more importantly, the 2008 forecasts have
hardly budged: they have been revised down just But as a result of these changes, there has been a
1% over the past three months, with analysts now slight deterioration in earnings momentum (Chart
expecting 8% growth this year for Asia ex Japan 3 – the change over the past six months in the 12-
(compared to 11% at the time of the last quarterly. month forward EPS forecast). Partly because this
year’s growth is forecast to be only half of last
Within these numbers, however, there is quite a
year’s, momentum has slipped from a peak of
lot of divergence between markets. The more
14% late last year to only 9% and will slip further
cyclically-sensitive economies have indeed seen
unless 2008 forecasts are revised up. The market
downward revisions (Table 5). Most notably,
has in the past reacted quite sensitively to
analysts have revised down 2008 (calendarised)
momentum. It is also slightly concerning that 57%
forecasts for Japan by 12% over the past three
of analysts’ revisions have been downward since
months. However, in our view, the current
the start of the year (Chart 4). Downward
forecast of 9% growth for this year will be hard to
revisions have been particularly noticeable in
achieve in the face of the strong JPY. From a top-
Taiwan (79% of all revisions) and Korea (62%).
down perspective, we forecast that Japanese
On the other hand, analysts continued to revise up
earnings will decline this year. Forecasts for
in India, Hong Kong, Indonesia, and Malaysia.
Taiwan, Australia, and Korea have also been
revised down over the past few months. Our conclusion is that so far there are few signs of
an earnings recession, although more significant
By contrast, forecasts for China and India
downward revisions are possible in the coming
continue to be revised up slightly, by 2% and 1%,
months.
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
18
nguon tai.lieu . vn