08.10.08+hsbc+next+problem+growth

Macro Equity Strategy Q4 2008

Main contributors Garry Evans* Pan-Asian Equity Strategist +852 2996 6916 [email protected] 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.

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.

Next problem: growth

Steven Y. Sun, CFA* CFA Regional Equity Strategist +852 2822 4298 [email protected]

Akane Nishizaki* Strategist +813 5203 3943 [email protected]

Next problem: growth It will start to wilt

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.

Vivek Ranjan Misra* Equity Strategist HSBC Bank Plc +91 80300 13699 [email protected] Vivek joined HSBC in May 2005 and works for the equity strategy team. Previously, he worked in the manufacturing sector and as an M&A analyst in the oil and gas sector. Vivek is a chemical engineer from Indian Institute of Technology (IIT) and has an MBA from the University of Rochester.

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.

Equity Strategy

Jacqueline Tse* Strategist +852 2996 6602 [email protected]

Leo Li* Strategy Associate +852 2996 6919 [email protected] 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.

Risk aversion won’t ease quickly, but it is unlikely to get much worse. The focus now will shift from rising risk to falling growth. As global growth slows, so will Asian exports, GDP growth and earnings. With valuations perhaps 15-20% above rock-bottom levels, Asian stock markets are likely to fall for another quarter or two. We stay defensive, and favour markets such as China and Singapore, which should have limited downside risk but also the chance of a good bounce when the bottom is reached.

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.

By Garry Evans

Q4 2008

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

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Equity Strategy Asia Pacific Fourth Quarter 2008

Country and sector weightings, and the key reasons for our view 1. By country Neutral

HSBC ___rec weighting___

Last quarter

Japan

47.5% 47.5%

Neutral

Neutral

Australia

15.1% 13.0%

Under

Under

China

9.0% 11.0%

Over

Over

Korea

7.6%

6.5%

Under

Neutral

Taiwan

6.0%

5.0%

Under

Under

Hong Kong

4.9%

5.0%

Neutral

Neutral

India

3.7%

4.0%

Neutral

Under

Singapore

2.8%

4.5%

Over

Over

Malaysia

1.4%

2.0%

Over

Over

Indonesia

0.9%

0.5%

Under

Under

Thailand Philippines New Zealand Pakistan Vietnam

0.7% 0.2% 0.2% 0.1% 0.0%

0.0% 0.0% 0.0% 0.0% 1.0%

Under Under Under Under Off-bmk

Under Under Under Under Off-Bmk

Rel perf Key pluses last 3M 4.4% As a developed market, should be fairly stable Valuations suggest downside risk is limited -7.1% PE at lowest level since early 1990s -5.1% Pro growth policymaking to provide support PE only 9.1x 2009 earnings -3.2% President Lee likely to start reform programme -8.1% Negotiations with Beijing -2.3% Fed to cut rates further Strong China growth continues 9.4% Monetary policy to be eased Domestic investors remain positive -1.7% Developed economy, defensive market Stock market relatively immune to slower exports 3.9% Most defensive market in Asia Valuation low, earnings forecasts conservative -6.7% Structural improvements -2.5% 30.3% 14.6% -6.3% 46.1% Non-correlated, exciting long-term story

Key minuses Corporate earnings depend on global economy Stock market reliant on foreign buying Structural problems like current account deficit Hurt by fall in commodities prices Regulatory risk Earnings visibility Risk of a housing crisis Exports likely to slow Further downward earnings revisions likely Highly dependent on tech exports Property prices to fall 10% Liquidity drying up as RMB not appreciating Slowdown in corporate earnings likely Political uncertainty ahead of election GDP growth to slow to 4% this year Political uncertainty Too risky in current environment Next year’s elections add to uncertainty Political situation remains dangerous High risk Few interesting investible stocks Political situation still very unstable Valuation at premium to other Asian markets Earnings outlook very unclear

Source: HSBC

w 2. By sector Neutral

HSBC ___rec weighting___

Last quarter

Rel perf Key pluses last 3M

Financials

26.6% 23.0%

Under

Under

4.8%

Industrials

14.6% 18.0%

Over

Under

IT

12.8% 11.0%

Under

Under

-6.5% Infrastructure spending should hold up well Cheap – on 9x 2009 earnings -3.4%

Consumer discretionary Materials

11.4%

9.0%

Under

Under

4.8%

11.4%

9.5%

Under

Under

Telecoms

5.6%

7.0%

Over

Over

Energy Consumer staples Utilities

5.3% 5.1%

5.5% 5.0%

Neutral Neutral

Neutral Over

3.9%

6.0%

Over

Neutral

Healthcare

3.3%

6.0%

Over

Over

Source: HSBC

-17.7% Metals prices may not fall much further 6.9% Stable earnings Subscriber growth and ARPUs to stay strong -10.2% Refiners will be helped if crude stays at $100 9.6% 20.4% Classic defensive; high dividend yields Lower coal prices to help Chinese IPPs 19.3% Defensive Structural growth (demographics, better R&D)

Key minuses NPLs rising in many Asian countries Regulators trying to limit Chinese banks’ profits Real estate markets at risk in HK, India, China Corporate capex could be cut End-demand likely to fall further Inventories being purged; production to be cut US and European consumers won’t spend Asian consumers could tighten belts, too Supply increasing, for example in iron ore Earnings estimates are too high Already well owned Demand likely to soften Weakening consumer demand Valuations stretched

Few large cap stocks

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Equity Strategy Asia Pacific Fourth Quarter 2008

Charts of the quarter 3. Risk measures have spiked

…but can they really get any worse?

1000

 Spreads on Asian corporate bonds have widened dramatically. A BBB rated Asian corporate now pays 512bps over Treasuries for five-year money compared to 120-130bps before the Credit Crunch started.

500

 Most worryingly, risk measures showed no sign of coming down even as the likelihood increased of Congress passing the bank rescue bill; rather, they continued to spike.

0

 Risk aversion is unlikely to disappear, or even ease much, any time soon. But can it really get any worse?

May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08

1500

AAA BB+

A B+

BBB

Source: HSBC

4. Export growth is almost certain to slow

…but a good deal of slowdown is already priced in

100

40 30 20

50

10 0

0

-10 91

93

95

97

99

01

03

05

07

-20

-50 Total Ex ports

 We think market attention is going to shift away from rising risk towards falling growth.  The most immediate impact on Asia is likely to come from slowing exports. So far, these have held up remarkably well – indeed, export growth has even accelerated this year to 21% from 17% last December. But with global growth slowing, surely this cannot last.  That may not be as serious for equities as it sounds. The equity market has clearly already discounted a serious slowdown in exports, perhaps to as much as a 10% y-o-y decline, which was what happened in both the 1998 and 2001 recessions.

MSCI AEJ (RHS)

Source: HSBC, CEIC, Bloomberg

5. Earnings growth forecasts have come down

…but by nothing like as much as in previous bear markets  Analysts have been slower to cut earnings forecasts this time than in the past.

40 35 '08

30 98

25 20

97

'01

'04

15 10

'00

5 0 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: HSBC, Datastream, IBES

 This year’s EPS growth forecast for Asia ex Japan has come down to -2%, compared to a forecast of +10% at the start of the year. But the 2009 forecast still looks over-optimistic at 14%.  In the 1997-8 bear market, a year after the stock market peaked, analysts had cut their 1997 EPS forecast by 51% and their 1998 one by 56%. After 2000, the cuts at the same point were 30% and 45%. This time, almost a year since the market started to fall, both 2008 and 2009 earnings forecasts have been cut by only 17%.

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Equity Strategy Asia Pacific Fourth Quarter 2008

6. Price/book is still 1.7x, versus previous bottoms of 1.2x

…but better ROE means it may fall only to 1.4x or 1.5x  The PB ratio for MSCI Asia ex Japan has typically bottomed (in 1997, 2001 and 2003) at 1.2x. Having peaked at 3.3x last year, it has now fallen back to 1.7x. But that does not necessarily mean we still have 29% to fall before hitting a firm bottom.

3.5 AEJ 3.0

 ROE has trended higher over the past few years. ROE peaked at 15% before the Asia Crisis, and then at 14% at the height of the TMT bubble in 2000. This time, however, forecast ROE reached as high as 18.5% at the beginning of this year.

2.5 2.0

 If ROE also bottoms at a higher level than previously, then PB may not fall to 1.2x as in previous bear markets, but maybe to only 1.4x or 1.5x. In this case, stocks may have only 12-18% to fall before they hit an ultra-cheap level.

1.5 1.0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: HSBC, IBES, Datastream

7. In the last two bear markets, indexes fell 66% and 57%

So far this time, the fall is only 39%  The 1997-8 bear market lasted 14 months and saw the index fall in total by 66%; the 2000-1 decline was 19 months and 57%.

110 100 90 80 70 60 50 40 30

 This bear market has so far lasted 11 months and seen the index fall 39%.  On the pattern of previous bear markets, this one would end between December and May, and would bottom between 36% and 20% lower than the current level.

-50

0

50 100 150 200 250 300 350 400 450 500 94

97

00

07

Source: HSBC, Bloomberg

8. US house prices are likely to fall further

…which means the slowdown could be prolonged  How long and strong will the rebound be when it comes? The unresolved strains in the global financial system mean it could be a stuttering rebound, with stock market returns after the initial bounce remaining quite poor for some time.

250 200

 Our biggest worry is that the US housing market could remain weak for years. The Case-Shiller index has already fallen 21% from its peak in June 2006. But futures (the dotted line in the chart) imply a further 15% decline, with prices not bottoming until the end of 2010.

150 100 50 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: Bloomberg

 A glance at the chart suggests even the futures may be too optimistic. House prices rose by 226% between 2000 and 2006. The decline implied by futures would take them back only to the level of summer 2003.

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Equity Strategy Asia Pacific Fourth Quarter 2008

Summary It has been a funny bear market. While stocks have fallen 39% in Asia this year, economic growth, exports and earnings all look fairly robust. Unfortunately, that is about to change. We see analysts’ and economists’ forecasts being cut sharply over the next few months, as the global economy goes into recession. Valuations in Asia are still 15-20% away from rock-bottom levels, so the bear market is unlikely to end just yet. But don’t get too bearish either – the world is not about to end. And remember that when Asian stocks rebound, they tend to rebound big, at least to start with.

From risk to growth Consensus is still too optimistic about growth The 39% fall in MSCI Asia ex Japan so far this year has been all about derating, rather than worsening growth. The forward PE for the region has been derated from 15.6x at the end of last year to 10.3x. But analysts’ forecasts for earnings growth in 12 months’ time have stayed at around 10%. That is likely to change. It is improbable that Asian exports will keep growing at the current pace of 21% y-o-y if the world goes into recession. That means that GDP growth next year, particularly in the most cyclically sensitive markets such as Taiwan and Korea, could slow sharply. We forecast only 3.3% growth next year for Taiwan, versus a consensus forecast of 4.4%, and 3.4% in Korea against the consensus of 4.3%. Earnings forecasts will have to come down, too. So far, analysts have cut their EPS forecasts for this year and next by only 17%. In the 1997-8 bear market, they had cut by 56% at this stage, and in 2000-1 by 45%. In particular, analysts still forecast 14% growth in earnings for 2009. That is far too optimistic. If past bear markets are anything to go by, that forecast could be cut to as little as -15%.

1. Key changes in view

Raise Lower Raise Raise Lower

India Korea Industrials Utilities Consumer staples

To

From

Reason

Neutral Underweight Overweight Overweight Neutral

Underweight Neutral Underweight Neutral Overweight

Long-term story remains good; domestic investors supportive Credit risk has risen significantly; exports to slow Infrastructure likely to prove more resilient than consumption Defensive; Chinese utilities should return to decent profits Valuations stretched; consumption likely to slow

Source: HSBC

1

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Equity Strategy Asia Pacific Fourth Quarter 2008

This is not to say that risk aversion will disappear. The extraordinary events of the past few weeks mean that banks – and investors – will be reluctant to take a lot of risk for some time to come. But we do not see measures of risk getting much worse. Spreads on sub-investment Asian bonds have risen to more than 1000bps over US Treasuries and the US dollar TED spread is at a historic high of 380bps. With the bank rescue bill now passed by Congress, spreads should ease a little – which could trigger a bear-market rally in equities in October and November.

Downside limited to 15-20% Our analysis of various valuation measures suggests that, if Asian equities fall another 15-20%, they will be at previous bear market rock-bottom lows. Price/earnings ratio and dividend yield, for example, are within 10% of historic lows and, even if we take into account lower-than-forecast earnings growth and dividend cuts, the downside is probably limited to 20%. Price/book has fallen to 1.7x from a high of 3.3x. Given the trend improvement in ROE over the past few years, we do not see PB falling to previous lows of 1.2x – 1.4-1.5x is more likely. The pattern of previous bear markets also suggests that a further fall of 20% is the near-worst case scenario. Our baseline scenario is that slowing growth will pull Asian equities down for another one to two quarters. Our targets assume that most indexes will end the year at a lower level than now (Table 2). But it is wrong to get too bearish. Remember that after the last two bear markets in 1997-8 and 2000-1, Asian stocks rose by 46% and 47% respectively in the first six months after the bottom. That is why our index targets assume a rebound of 20-30% during 2009.

Market calls How to have the best of both worlds In the current uncertain environment, we want to minimise risk. But we also don’t want to miss out completely on the rebound in markets when it happens – perhaps in early 2009. In our view, the way to have the best of both worlds is through exposure to Asia’s two structural growth stories, China and India. We think investors at some point will become willing to look through the shortterm uncertainties to the increasingly attractive (because now reasonably valued) long-term story. China,

2. Index targets Index

Japan Australia China Korea Taiwan Hong Kong India Singapore Malaysia Indonesia Thailand Vietnam MSCI Asia ex Japan MSCI Asia Pacific Source: HSBC

2

TPX Index AS51 Index MXCN Index KOSPI Index TWSE Index HSI Index Sensex Index FSSTI Index KLCI Index JCI Index SET Index VNINDEX Index MXFEJ Index MXAP Index

Current level 30 Sep 2008

Target end-2008

Potential upside

Old end-2008 target

Target end-2009

Upside vs 2008

Old end-2009 target

1,087 4,601 46 1,448 5,719 18,016 12,860 2,359 1,019 1,833 597 457 344 107

1,100 4,500 48 1,300 5,500 18,000 12,000 2,200 1,000 1,700 550 450 333 106

1.2% -2.2% 4.4% -10.2% -3.8% -0.1% -6.7% -6.7% -1.8% -7.2% -7.8% -1.5% -3.2% -1.0%

1,350 5,500 70 1,300 7,500 24,000 14,000 3,300 1,350 2,000 750 400 480 140

1,250 5,000 60 1,400 5,750 22,000 15,000 2,800 1,150 1,900 600 550 389 121

13.6% 11.1% 25.0% 7.7% 4.5% 22.2% 25.0% 27.3% 15.0% 11.8% 9.1% 22.2% 16.8% 14.5%

1,400 5,750 77 2,000 8,000 25,000 15,000 3,400 1,450 2,000 750 450 500 145

Equity Strategy Asia Pacific Fourth Quarter 2008

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in particular – where we remain overweight – should see economic growth remain strong. We look for GDP growth of 9.1% next year. Earnings growth for the MSCI universe, even if it comes in below the current consensus forecast of 17%, is unlikely to fall below 10-15%. And you can buy this growth for a prospective PE of 9.4x. Moreover, the Chinese government has a lot of ammunition if it needs to stimulate growth, either through an infrastructure spending programme or pro-market reforms. India is not quite so straightforward. The general election, which must be held by next May, complicates the picture. And the market is not as cheap, on a PE of 12.2x. But a cut in interest rates and support from domestic investors will help. We raise India to neutral. We keep our overweights on Asia’s two most defensive markets, Singapore and Malaysia. While both have seen large falls this year, they have outperformed Asia ex Japan by 14% and 9% respectively. We look for reasonably decent economic growth next year, 4.8% in both countries. Both have a selection of blue-chip companies with transparent earnings prospects. In line with our defensive posture, we also keep Hong Kong and Japan at neutral. Both have problems that make us hesitate about going overweight (Japan’s dependence on overseas markets for earnings growth; the likelihood that Hong Kong real estate prices will fall 10% next year). But, as lower-beta developed markets, both should emerge relatively unscathed from further market weakness, and both should see decent bounces when the market bottoms. Our biggest underweight remains Taiwan because of its dependence on exports and the technology sector. Analysts have got realistic about this year’s earnings growth, where they now forecast a 20% decline. But next year’s forecast of 12% EPS growth will have to be cut. We are also unenthusiastic about the chances of major breakthroughs in negotiations with Beijing. We lower Korea from neutral to underweight. We see growing risk of a housing and debt crisis. Export growth has held up rather well, but is now likely to slow sharply, which makes the consensus forecast of 15% EPS growth in 2009 look too optimistic. We also look for GDP growth to slow to 3.4% next year. We remain underweight on most of the smaller ASEAN markets, which are simply too risky and high beta for the current environment. We are also underweight Australia, which we believe will not prove as defensive in this recession as in the past. The country has too many structural problems: current account deficit, overheated property market and dependence on commodities.

3

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Equity Strategy Asia Pacific Fourth Quarter 2008

3. Key country and sector recommended weightings

Japan Australia China Korea Taiwan Hong Kong India Singapore Malaysia Indonesia Thailand Philippines New Zealand Pakistan Vietnam

Financials

Industrials

IT

Consumer discretionary

Materials

Telecoms

Energy

Consumer staples

Utilities

Healthcare

Overall

Under

Over

Under

Under

Under

Over

Neutral

Neutral

Over

Over

Neutral Under Over Under Under Neutral Neutral Over Over Under Under Under Under Under Off-Bmk

Under Under

Under

Under

Under Under Under

Over Over Under Over Over Over

Under Under Under

Under Under Under Under Under

Over Under Over Over Under

Under Over Over Over

Over Over

Under

Over

Under

Over

Over

Source: HSBC

Sector calls Stick to defensives; prefer infrastructure to consumption Spending a lot of time thinking about sector allocation has not been a very valuable exercise recently. If you had judged correctly at the beginning of 2008 that we were in a bear market, you would, without thinking about it very hard, have overweighted utilities, healthcare and consumer staples, and avoided materials, financials, industrials and technology. You would have been exactly right. Since we expect that the bear market has at least another quarter or two to run, and that earnings growth is likely to disappoint next year, it makes sense to stick largely to the same sector allocation model. Our preference is for sectors where growth is structural rather than cyclical, where downward earnings surprises are relatively unlikely, and where leverage and financial risk are low. In an environment of slowing global growth, therefore, our preference is for sectors such as telecoms and healthcare, where decent growth is fairly assured even if the cycle continues to turn down. We stay overweight both. We raise utilities from neutral to overweight, particularly since in China the squeeze on profits from higher coal prices should end. We remain squarely underweight IT, financials and consumer discretionary. Our main change this quarter is to raise industrials from underweight to overweight, and to cut consumer staples from overweight to neutral. We believe that infrastructure spending is likely to hold up better than consumer spending in the slowdown in coming quarters. Moreover, valuations in consumer sectors have got stretched; those in capital goods now look cheap.

4

Over

Under Over

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Equity Strategy Asia Pacific Fourth Quarter 2008

Stock picks Buy quality, sell risk For our high-conviction buy ideas, we stick to a solid, no-surprises list (Table 4). The stocks included are all liquid, large-cap names, with solid balance sheets, good long-term prospects for earnings growth and quality managements. We have avoided most cyclical sectors, and also stocks in markets such as Taiwan and south-east Asia, which we see as high risk. New names this quarter are Singapore Airlines, a bluechip name which should additionally benefit from lower oil prices; Petrochina, which we think will benefit from the falling crude price, relaxation of government energy price restrictions, and the buyback plan of its parent; China Resources Power to give us exposure to the defensive utilities sector where we see profitability rebounding as coal prices fall; Shanghai Electric, since we see infrastructure spending in China being stronger than consumption; and Bharti Airtel, a good example of a long-term growth story now trading on attractive valuations. Our highest-conviction sell ideas generally reflect our nervousness about (1) balance sheet risk, (2) funding issues for banks in certain markets, and (3) the risk of a US consumer slump hurting the IT sector. We include Tokyo Electron and Chi Mei on expectations that demand for electronics products will slow sharply; China Eastern on worries about its balance sheet and long-term future; ICICI Bank in India and Sumitomo Mitsui in Japan on concerns about funding issues and rising NPLs; and Korea’s SK Telecom, where we see excess competition for new subscribers denting profits until the end of 2009.

4. HSBC's top 10 high-conviction buy ideas Code

Name

836 HK 857 HK 2727 HK 823 HK 19 HK BHARTI IN LT IN 9433 JP 033780 KS SIA SP

CHINA RESOURCES PWR PETROCHINA SHANGHAI ELECTRIC LINK REIT SWIRE PACIFIC LTD BHARTI AIRTEL LARSEN & TOUBRO KDDI CORP KT&G CORP SINGAPORE AIRLINES

Country/ region

Sector

CH CH CH HK HK IN IN JP KR SG

Utilities Energy Industrials Real estate Industrials Telecoms Industrials Telecoms Consumer Airlines

Country/ region

Sector

CH IN KR TW JP JP

Airlines Financials Telecoms IT Financials IT

HSBC rating Potential upside to target price (%)

Price (local cur)

Market cap (USDm)

51.6 48.4 66.7 27.7 45.7 23.6 29.5 47.2 17.9 28.9

17.02 (HKD) 8.56 (HKD) 2.40 (HKD) 16.84 (HKD) 70.00 (HKD) 810.55 (INR) 2,550.55 (INR) 598,000.00 (JPY) 89,100.00 (KRW) 14.74 (SGD)

9,175 197,430 6,262 4,683 8,248 33,486 16,228 25,295 10,864 12,287

HSBC rating Potential upside to target price (%)

Price (local cur)

Market cap (USDm)

1.33 (HKD) 600.10 (INR) 203,500.00 (KRW) 22.60 (TWD) 684,000.00 (JPY) 5,510.00 (JPY)

962 14,537 12,963 5,159 50,906 9,352

Overweight (V) Overweight (V) Overweight (V) Overweight Overweight Overweight (V) Overweight (V) Overweight Overweight Overweight

Source: HSBC

5. HSBC's top sell ideas Code

Name

670 HK ICICIBC IN 017670 KS 3009 TT 8316 JP 8035 JP

CHINA EASTERN AIRL ICICI BANK SK TELECOM CHI MEI OPTOELECT SUMITOMO MITSUI FIN TOKYO ELECTRON

Underweight (V) Underweight (V) Underweight Underweight (V) Underweight (V) Underweight (V)

-62.4 -5.0 -15.0 -20.4 -26.9 -14.0

Source: HSBC

5

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Equity Strategy Asia Pacific Fourth Quarter 2008

Contents Investment strategy Next problem: growth

Earnings

7 7

20

2008 EPS forecasts have been cut a little…

20

…but 2009 EPS has even more room for decline

20

China (overweight) Investors’ dilemma

Taiwan (underweight) Further to fall

Hong Kong (neutral) Valuation

22

Forward PE close to bottom

22

PB not yet low enough…

22

Stay defensive

India (neutral) The bad news and the good

But bottom might be close

Supply and demand

24 24

Equity issuance difficult in current environment

24

Politics remains an important theme for markets

Country profiles Japan (neutral) Rudderless boat on rough seas

26

ASEAN (overweight) Stick to defensive markets

Sectors and stocks

More risks than are apparent

Korea (underweight) Credit risk rises

6

46 46

50 50

54 54

58 58

65

Stick to the obvious

65

What we like

67

What we don't like

67

Quantitative scorecards

68

Scorecards

69

26

29 30 30

Top stock picks What to buy – and what not

Australia (underweight)

42

22

USD31bn of foreign money left Asia in 3Q08

Politics and risk

42

72 72

34 34

38 38

Disclosure appendix

90

Disclaimer

93

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Equity Strategy Asia Pacific Fourth Quarter 2008

Investment strategy  Equities have crashed this year mainly because of risk aversion.

While risk won’t ease quickly, it is unlikely to get much worse  The focus will now shift to a slowdown in growth – of US

consumption, exports, Asian GDP and earnings  Being more like a normal recession, that is easier to deal with.

With valuations only 15-20% away from rock-bottom, the bad times – at least in Asia – may last only another quarter or two

Next problem: growth

EPS growth in China and 11% in India this year – and then 14% for the region as a whole next year.

Given the way that Asian equities have crashed this year (MSCI Asia ex Japan was down 39% in US dollar terms by the end of September), it is remarkable how well growth has held up. The consensus expects Chinese and Indian real GDP to grow by 9.9% and 7.5% respectively this year, and 9.1% and 7.6% next. Analysts may have cut

What pulled stock indexes down was largely risk aversion – and a consequent dramatic repricing of risk assets, including equities. Chart 2 is a simple way of thinking about the drivers of a stock market, breaking the return down into the 12month forward PE and the 12-month forward consensus earnings expectation. The forward PE for MSCI Asia ex Japan fell from 15.6x at the end

their earnings growth forecasts for Asia ex Japan this year to below zero, but they still expect 13%

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

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

Mar-05

Dec-04

Sep-04

Jun-04

Mar-04

Dec-03

Sep-03

Jun-03

Mar-03

80

Source: HSBC, Bloomberg

7

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Equity Strategy Asia Pacific Fourth Quarter 2008

of December 2007 to 10.3x by end-September. That explains almost all the decline in the stock market. Over the same time, the 12-month forward earnings forecast has stayed around 1012% – analysts have cut their 2008 EPS growth forecast from 10% to -2% over the course of the year, but they still expect 14% growth in 2009.

3. US dollar versus Asian currencies (MSCI weighted)

130 125 120 115 110 105 100 95

2. Drivers of the stock market

USD/Asia

90 PE 18

88

16

Jan

14

Apr

12

Jun

10

Oct

-10% -20% -30% -40%

8 -2%

+10% 0%

0%

2%

4% 6% 8% EPS grow th

10%

12%

14%

Source: HSBC

The other factor to bear in mind is currency movements. After five years of appreciation against the US dollar, Asian currencies have weakened this year (Chart 3). Since the beginning of the year, this has subtracted a further 6% from the performance of MSCI Asia ex Japan in US dollars versus that in local currency terms. (And the degree of depreciation is softened by the fact that Chinese shares, the largest component of the index, are denominated in Hong Kong dollars which are pegged to the US dollar. By contrast, this year the Korean won has fallen by 31% against the dollar and the Indian rupee by 19%.) HSBC’s view is that the dollar will continue to appreciate, including against Asian currencies.

91

94

97

00

03

06

Source: HSBC, MSCI

Our investment thesis this quarter is that market attention is going to shift away from rising risk towards falling growth. We do not see valuations in Asia falling that much further. As we argue below, Asian stock markets are within 10-20% of historic lows on most measures. But expectations of growth are likely to be reduced very rapidly. That suggests, referring back to our schematic in Chart 2, that forward PE for the market will not fall much below its current level, but earnings forecasts could be slashed quite quickly.

Risk will stay high for a while, too That is not to say that risk aversion will disappear altogether, or even ease much, any time soon. But, with the passage of the financial system rescue bill in the US Congress, it is probably fair to say that it will not get any worse. Measures of risk aversion are at historic highs. At the end of September, with one-month USD Libor rising to over 4% and one-month Treasury bills falling to 0.2%, the TED spread reached 3.8%, compared to pre-Credit Crunch levels of 3040bps. That is the highest level since at least the 1970s. Perhaps a better measure of bank risk is the spread between interest rate swaps (OIS) and Libor. Since the OIS incorporates minimal credit exposure (the flows are swapped and netted at

8

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Equity Strategy Asia Pacific Fourth Quarter 2008

maturity) whereas inter-bank lending is pure counterparty risk, this is a cleaner measure of bank credit risk than the TED spread. As shown in Chart 4, the OIS spread has blown out in an extraordinary way to 2.7% – whereas the average spread in 2004-6 was only 9bps.

5. Spread over Treasuries of Asian USD 5-year corp bonds

1500 1000 500 0 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08

4. 3-month OIS spread (USD)

3.0 2.5

AAA BB+

A B+

BBB

2.0 Source: HSBC

1.5

Source: HSBC, Bloomberg

Closer to home in Asia, spreads on corporate bonds have also widened dramatically (Chart 5). A BBB rated Asian corporate would now pay 512bps over Treasuries for five-year money – if it could issue a bond at all – compared to 120130bps before the Credit Crunch started. And for sub investment grade companies – which we estimate comprise one-quarter to one-third of the MSCI Asia ex Japan universe – the situation is even more dire: a B+ rated corporate issuer now pays 13% over Treasuries. Most worryingly, none of these risk measures showed any sign of coming down even as the likelihood increased of Congress passing the bank rescue bill; rather, they continued to spike.

6. Implied and historic volatility – six Asian markets

80 70 60 50 40 30 20 10 0

Imp v ol

10D hist v ol

Jul-08

08

Apr-08

07

Jan-08

06

Oct-07

05

Jul-07

04

Apr-07

03

Jan-07

02

Oct-06

0.0

Jul-06

0.5

But can it really get any worse? Measures of stock market volatility are at, or close to, previous peak levels. The VIX index, measuring the implied volatility on the US S&P500 index, has spiked to 45 – higher than the peak during the TMT bubble or at the time of the bail-out of LTCM in 1998. In Asia, the average implied volatility of the six indexes that have options (Japan, Korea, Hang Seng, HSCEI, Taiwan and India) reached 47% at the end of September, only slightly lower than the peak of 53% in January this year (Chart 6).

Apr-06

1.0

Source: HSBC, Bloomberg

Inter-bank, commercial paper and other money markets have increasingly dried up – even in Asia – with banks generally unwilling to take any counterparty risk. Since this is a situation without parallel in history, never mind in the memories of any of today’s market participants, it is impossible

9

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Equity Strategy Asia Pacific Fourth Quarter 2008

to predict with conviction how this seizing-up of the credit markets will pan out. But we find it hard to see how it can get much worse. If credit spreads were to start to come down a little and money markets to begin functioning again, this could have a dramatic positive short-term impact on equities. It must not be forgotten that bear markets tend to see tremendously strong, if short-lived, rallies. In the 2000-1 bear market in Asia ex Japan, for instance, there were five rallies of 10% or more, although the index eventually fell 57% from peak to trough. In the current bear market, early on there were three strong bear market rallies (see Chart 7). But we have not had a 10% rally since May – five months now. Once the Q3 earnings season in the US is out of the way – and the Troubled Assets Relief Program (TARP) starts to function – it seems quite likely that there could be another bear market rally. Given the depth of the decline over the past few months, it could be quite a powerful one.

back on capital investment, US consumers repairing their balance sheets by increasing savings, and falling commodities prices. Leading indicators have just recently started to turn down sharply. The US manufacturing ISM (Chart 8) – which we have long regarded as the single best indicator of the cyclical factors driving Asian equities – fell suddenly in September to 43.5, having been stuck at around the 50 level (the dividing-line between expansion and recession) since the beginning of the year. In previous recessions, it has typically fallen to 40-41 (see, for example, 1991 or 2001). And the bottom for the stock market tends to be roughly simultaneous with the bottom in the ISM (not surprising, since both are leading indicators of the economy). That suggests that stocks have further – but perhaps not that much further – to fall. Of course, that assumes this is a fairly normal recession – in really nasty ones, such as 1975 or 1980, the manufacturing ISM fell to around 30. 8. US manufacturing ISM vs. MSCI Asia ex Japan

7. We haven’t had a bear market rally for a while

65

650

60

Top

600

10.0%

80% 60% 40%

55

20%

500

50

0%

450

45

19.4%

13.5%

550

400

-20% -40%

Oct-08

Sep-08

Aug-08

Jul-08

Jun-08

Apr-08

May-08

Mar-08

Jan-08

Feb-08

Dec-07

Oct-07

Nov-07

ISM Manufacturing (LHS)

2008

2005

2002

1999

300

1996

-60% 1990

350

1993

40

MXFEJ y /y

Source: HSBC, Bloomberg

Source: HSBC, Bloomberg

Exports

Where growth will slow But with growth starting to slip, the rally should not be taken as a signal that the bear market is over. In our view, a nasty combination of factors will threaten global growth over the coming quarters: weakening consumer sentiment, a drying-up of credit availability, companies cutting

10

The most immediate impact on Asia is likely to come from slowing exports. So far, these have held up remarkably well – indeed, export growth has even accelerated this year (Chart 9). The three-month moving average of Asian total export growth has risen to 21% from 17% last December (see Chart 9). Korean exports, for example, grew

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Equity Strategy Asia Pacific Fourth Quarter 2008

28% y-o-y in September, Chinese and Indian exports 22% and 29% respectively in August. While exports to the US have slowed to only 6% y-o-y, exports to the EU (+22%), Asia (+22%) and commodity producing countries (for example, Australia +45%, Middle East +21%) continue to hold up well. Surely, this cannot last. Indeed, some lead indicators of exports have started to slip: Taiwan export orders in August, for example, slowed to 5% y-o-y, the lowest level since May 2003. It seems highly likely, then, that export growth will begin to slow quickly over the next few months. 9. Asian export growth vs MSCI Asia ex Japan

10. Average real GDP growth (MSCI weighted) 7.5 7.0

Asia ex -Japan

6.5 6.0 5.5 5.0 4.5 4.0 Jan-05

Jan-06

Jan-07

2006

2007

Jan-08 2008

2009

Source: Consensus Economics

100

40 30 20

50

10 0 -10 91

has been cut to 6.1% from 6.7% at the end of last year, and the 2009 forecast by a similar amount.

0 93

95

97

99

01

03

05

07

-20

-50 Total Ex ports

MSCI AEJ (RHS)

Source: HSBC, CEIC, Bloomberg

That may not be as serious for equities as it sounds. Chart 9 also shows the y-o-y change in the MSCI Asia ex Japan index. The correlation with exports is quite good (correlation since 1998, using a three month lag, is 78%). The equity market has clearly already discounted a serious slowdown in exports, perhaps to as much as a 10% y-o-y decline, which was what happened in both the 1998 and 2001 recessions. GDP

Economic growth in Asia has already been revised down a little, but is likely to slow further. Chart 10 shows the consensus forecast for real GDP growth in Asia ex Japan (weighted by the MSCI index weights). The 2008 growth forecast

HSBC believes that economies – particularly export-oriented ones – could slow significantly more than this, particularly next year. Our economists are happy that growth in China and India will hold up – partly because of government infrastructure spending in the face of slowing exports – but they are well below consensus in forecasts for Thailand (3.1% next year versus consensus of 4.6%), Taiwan (3.3% versus 4.4%), Korea (3.4% versus 4.3%), and the Philippines (3.9% versus 4.8%), as shown in Table 11. 11. HSBC and consensus real GDP growth forecasts (% y-o-y) 2007 Actual CN IN ID MY HK PH TH KR TW SG AU JP AsiaPac AEJ

2008F 2009F HSBC Consensus HSBC Consensus

11.9 9.0 6.3 6.3 6.3 7.2 4.8 5.0 5.7 7.7 2.5 2.1 3.7 7.2

9.7 7.5 6.1 6.0 4.5 4.1 4.1 3.9 3.9 3.8 2.7 0.8 2.9 5.8

9.9 7.5 5.9 5.5 4.4 4.7 4.8 4.4 4.3 4.2 2.6 0.9 3.0 6.1

9.1 7.3 4.9 4.8 3.9 3.9 3.1 3.4 3.3 4.8 3.0 0.6 2.7 5.4

9.1 7.6 5.6 5.1 4.2 4.8 4.6 4.3 4.4 4.6 2.6 0.9 2.9 5.9

Source: HSBC, Consensus Economics

11

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Equity Strategy Asia Pacific Fourth Quarter 2008

Overall, they look for MSCI-weighted growth next year of 5.4%, versus 5.8% this year and versus a consensus forecast of 5.9%.

13. Movements in the 2001 GDP forecast

10 8

Consensus economic forecasts still look rather optimistic in the light of what has happened over the past few years. The consensus still forecasts 6% GDP growth for Asia over the next 12 months (again, on an MSCI index weighted basis). While that may not be as good as last year, it is significantly better than anything achieved before 2006 (see Chart 12). 12. GDP growth forecasts versus MSCI Asia ex Japan 8

80

7

60 40

6

20

5

0

4

-20

3

-40

2

-60 2001 2002 2003 2004 2005 2006 2007 2008 12-mth forw ard GDP f'cast MXFEJ y /y (RHS)

6 4 2 0 -2 Jan-01 -4

Apr-01 CH SG

12

IN TW

Oct-01

Jan-02

KR Ax J

Source: Consensus Economics

Table 14 shows how much the 2008 and 2009 forecasts have been revised down since last December, compared to how much the 2001 forecasts were revised down between January 2001 and the final result. The biggest revision down this time has come in Singapore, where 2008 growth has been cut to 4.2% from 6.3%, a 2.1ppt cut. But in 2001, four countries were cut by more than this. 14. Revisions to GDP forecasts: Jan-latest

Source: Consensus Economics, Bloomberg

Moreover, the degree by which the consensus economic forecast was cut in the 2000-1 recession (the only one, unfortunately, we have data for) was significantly bigger than the forecast cuts this time so far. For example, the 2001 GDP growth forecast for Asia ex Japan was cut from 5.3% at the start of 2001 to a final outcome of only 1.6% (Chart 13). In particular, Taiwan was cut from 5.0% to -2.2% and Singapore from 6.2% to -2.3%. Only China and India remained relatively resilient. While this recession is likely to be different in character – it is not as concentrated on a slowdown in technology-based capex, for example – it is notable that forecasts this time have not (yet) been cut by anything like as much.

Jul-01

SG PH AU HK CN IN JP KR MY ID TH TW AEJ

2001

2008

2009

-8.5 -1.1 -0.7 -3.8 0.6 -0.7 -1.5 -0.9 -5.5 -0.4 -1.7 -7.2 -3.7

-2.1 -1.2 -1.0 -0.8 -0.6 -0.6 -0.6 -0.5 -0.2 -0.2 -0.1 0.0 -0.6

-1.4 -1.0 -0.9 -1.1 -0.7 -0.6 -1.1 -0.7 -0.8 -0.5 -0.3 -0.3 -0.8

Source: Consensus Economics

Earnings

Analysts have also been slower to cut earnings forecasts this time than in the past. This year’s EPS forecasts have come down, it is true. Analysts are now forecasting -2% growth in Asia ex Japan for the current year, compared to a forecast of +7% at the beginning of July, and +10% at the start of the year (Chart 15).

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15. Consensus forecast for EPS growth this year and next

25% 20% 15% 10% 5%

Jul-08

Apr-08

Jan-08

Oct-07

Jul-07

Apr-07

Oct-06

Jan-07

Apr-06

Jan-06

-5%

Jul-06

This y ear Nex t y ear

0%

Source: HSBC, Datastream, IBES

And, in the most cyclically sensitive markets, earnings have been slashed: for Taiwan, for instance, analysts have cut their 2008 EPS growth forecast to -20%. At the start of the year, they had reckoned +15%. As Table 16 shows, every market in Asia has seen forecasts cut to some extent but, in contrast to Taiwan’s 28% cut over the past six months, earnings in Hong Kong, Australia, Thailand, Malaysia, India and China have all been pared back by less than 4%. They will probably need to be revised down further. 16. Consensus EPS forecasts by country 2008 3-mth 6-month 2009 3-mth 6-month EPS revision revision EPS revision revision growth growth ID IN AU CN KR PH TW JP HK TH SG MY AP AEJ

16.3 19.3 9.1 13.3 3.5 0.8 -20.2 -4.0 -26.1 114.1 -3.4 -12.6 -2.7 -1.9

-5.0 -2.7 7.3 -2.1 -8.9 -7.4 -22.6 -3.4 -4.4 0.2 -2.3 -2.7 -10.4 -12.5

-6.6 -3.6 -2.2 -3.9 -7.4 -15.8 -28.1 -11.9 -0.8 -3.0 -6.3 -3.2 -17.7 -15.8

29.0 23.2 17.1 16.6 14.8 14.1 12.1 10.3 8.3 7.2 7.1 4.9 16.2 14.0

-1.6 -4.0 15.3 -3.3 -9.4 -9.5 -23.1 -5.8 -7.1 -1.0 -4.9 -7.5 -9.1 -13.6

3.2 -4.5 3.2 -3.5 -7.0 -19.1 -27.1 -14.6 -6.9 -3.2 -10.7 -8.9 -14.7 -16.3

Source: HSBC, Datastream, IBES

Moreover, the 2009 forecasts still look particularly over-optimistic. Analysts are forecasting 14% growth for Asia ex Japan, with even the slowest markets such as Malaysia and Singapore expected to see 5-10% growth, and the

best (Indonesia and India) 20%-plus. This suggests either that analysts are looking for a strong economic recovery next year or (more likely) that, in an environment where it is tricky to forecast even three months out let alone more than a year away, they have simply pencilled in the usual 10-15% for most of their coverage companies. And, indeed, in September the 2009 forecast at last showed the first signs of being downgraded. The overall growth rate for the region has fallen to 14%, from 16% at the end of August. China, in particular, has been cut to 17% from 19%, and Taiwan to 12% from 14%. Those numbers still look too high, but they are starting to come down quite quickly. But in previous bear markets, analysts were much quicker to cut forecasts. Chart 17 shows analysts’ consensus forecasts of the absolute EPS integer for MSCI Asia ex Japan over the past 10 years. The final point on each line is the actual EPS for that year. This enables us to see the magnitude of EPS changes over time in previous bear markets, for example 1997-8 or 2000-3. 17. Absolute EPS forecast by year – MSCI Asia ex Japan

40 35 '08

30 98

25 20

97

'01

'04

15 10

'00

5 0 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: HSBC, Datastream, IBES

In 1997-8, for instance, a year after the stock market peaked in July 1997, analysts had cut their 1997 EPS forecast by 51% and their 1998 one by 56%. After 2000, the cuts at the same point were 30% and 45%. This time, almost a year since the

13

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Equity Strategy Asia Pacific Fourth Quarter 2008

market started to fall, both 2008 and 2009 earnings forecasts have been cut by only 17% (Table 18). There is likely to be a lot further to go. In the end, the 1998 EPS forecast was cut by 68% and the 2001 one by 45%. Our rough guess would be that the 2009 EPS forecast could be cut by a total of 40% from the peak. That would imply that earnings next year for Asia ex Japan could fall by as much as 15% y-o-y (if we assume a small further cut in the 2008 forecast, too).

2003. Five markets in the region are lower than the bottom they reached even in the 2000-3 bear market (Japan, Australia, Singapore, Thailand and Malaysia). 19. 12-month forward consensus PE, MSCI Asia ex Japan 30 Forw ard PE - Asia ex -Japan 25 20 15 10

18. Analyst earnings cuts in previous bear markets EPS cut first Total EPS cut Date of market year after from market peak market peak peak 1997 1998

51.2% 55.8%

51.2% 67.6%

Jul-97

2000 2001

29.8% 24.6%

29.8% 44.7%

Feb-00

2008 2009

16.7% 16.5%

? ?

Oct-07

Source: HSBC, Datastream, IBES

How much further to fall? In a way, though, if our thesis is correct and this bear market shifts in nature from being the result of a US-engendered credit crisis to being driven by a normal economic slowdown, it will be easier for investors (and strategists) to cope with. Normal rules of thumb and historical relationships – which have not worked while unprecedented events were happening – will be of use again. We will be able to think, for example, about the valuation level at which the market is likely to bottom out. PE suggests 22%

On many measures, Asian equities are starting to look quite cheap. The 12-month forward PE ratio for MSCI Asia ex Japan, for instance, has fallen to 10.3x (see Chart 19). That is lower than it got to in the Asia Crisis of 1997-8 (when it bottomed at 10.8x) and not that far from the low of 9.0x in

14

5 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: HSBC, IBES, Datastream

Of course, that might not be very meaningful if, as discussed above, earnings have not come down as quickly this time as in previous bear markets. If we assume, for example, that Asia ex Japan earnings do not grow at all next year, forward PE would be 11.3x – cheap, but not bear market bottom levels. And if, as we suggested above, earnings fall by 15%, PE would be 12.8x. If earnings really come down that much, and PE bottoms out at, say, 10x, that would give 22% downside from the current level. We would suggest two better methods for judging when valuations have reached rock-bottom in a bear market: price/book ratio and dividend yield. Price/book suggests 12-18%

The PB for MSCI Asia ex Japan has typically bottomed out (in 1997, 2001 and 2003) at 1.2x. Having peaked at 3.3x last year, it has now fallen back to 1.7x (Chart 20). But does that mean we still have 29% to fall before hitting a firm bottom?

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Equity Strategy Asia Pacific Fourth Quarter 2008

20. Prospective price/book ratio – MSCI Asia ex Japan 3.5 AEJ 3.0 2.5 2.0

If that is the case, then PB may not fall to 1.2x as at the bottom of previous bear markets, but maybe to only 1.4x or 1.5x – it is better not to claim any spurious scientific accuracy about the exact level. In this case, stocks may have only 12-18% to fall before they hit an ultra-cheap level. Dividend yield suggests 19%

1.5 1.0 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Source: HSBC, IBES, Datastream

One hard-to-define factor to take into account is that ROE has trended higher over the past few years (and this despite, in most countries, leverage falling). As Chart 21 shows, ROE (based on oneyear forward forecasts) peaked at 15% before the Asia Crisis, and then at 14% at the height of the TMT bubble in 2000. This time, however, forecast ROE reached as high as 18.5% at the beginning of this year. While some of the improvement in the past five years was clearly cyclical, should we not also assume a structural improvement in ROE? This would suggest that the bottom for ROE will not be 9%, as in 1998, or 11%, as in 2002, but perhaps 3 or 4 percentage points higher, i.e. 14-15%. 21. 12-month forecast ROE, MSCI Asia ex Japan 20

15

10

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

5

Source: HSBC, Datastream, IBES

The story is similar for dividend yield. Currently, dividend yield (using this year’s forecast dividend) for Asia ex Japan is 3.2% (Chart 22). That is not far below the peaks of 3.6% reached in 1998 during the Asia Crisis and 3.4% reached in 2003. 22. Prospective dividend yield, MSCI Asia ex Japan 4.0 3.0 2.0 1.0 0.0 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Div idend Yield - Asia ex Japan Source: HSBC, IBES, Datastream

Price/book has the advantage that, except in a very nasty downturn, book value is relatively solid. Dividend yield is not so reliable, since dividends can be cut. But, even in deep recessions, it is surprising how little they are in fact cut. In 1998, for example, of the major markets, only Malaysia cut dividends by more than 20% (Table 23), though cuts in the small ASEAN markets were more drastic (Thailand -73%, the Philippines -33%). In the TMT bust of 2000-1, Korea and Taiwan both cut dividends by a little more than 10% over two years, but Singapore and Malaysia did not cut at all.

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Equity Strategy Asia Pacific Fourth Quarter 2008

Bottom comes when things are worst

23. Change in annual dividends – MSCI universe AU 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

HK

-1% 17% 4% -10% -14% -16% 15% 30% 16% -22% 2% -8% 9% 0% 8% 10% 36% 14% 24% 9% 2% 6% 5% 40%

IN

JP

KR

MY

SG

TW

3% 7% -13% 3% -2% -11% 13% -5% -38% -5% 1% 8% -5% -3% 57% -27% -1% 33% 10% -13% 67% 25% 24% -8% 2% 14% -9% 8% 0% -8% 17% 7% -3% 22% 6% -3% 20% -19% 70% 10% 10% 38% 17% 10% 27% 33% 19% 83% 35% 42% 43% 38% 55% 31% 3% 45% -12% 1% 12% 3% 41% -7% 14% 28% 46% 30% -6% 10% 14% 43% -10% 1%

Source: HSBC, Datastream, IBES

If we assume, then, that dividend yield rises to the previous peak of 3.6% and that dividends are cut by 10%, that would give 19% further downside for Asia ex Japan. …and history suggests 20%

And, while it is not a particularly scientific method of analysis, that sort of decline would be typical of previous bear markets in Asia. The 1997-8 bear market lasted 14 months and saw the index fall in total by 66%; the 2000-1 decline was 19 months and 57% (Chart 24). On the same pattern, this bear market would end between December and May, and would bottom between 36% and 20% lower than the current level. We doubt that this episode will turn out to be as bad for the region as the Asia Crisis, so probably 20% is a fair assumption for a near-worst case scenario. 24. Previous bear markets in MSCI Asia ex Japan 110 100 90 80 70 60 50 40 30 -50

0

50 100 150 200 250 300 350 400 450 500 94

Source: HSBC, Bloomberg

16

97

00

So when will the bear market end? It is always one of the trickiest moments for a fund manager: when to call the bottom of a bear market. Leave it too late, and you miss the initial rise, which is often the biggest. Time it too early, and your performance can suffer for months or years. For example, if you had called the bottom of the 2000-1 bear market six months too early in March 2001, it would have taken you almost three years to get your money back. As Table 25 shows, buying even three months too soon can be painful, as the last leg-down of a bear market – the capitulation stage – is often the nastiest. A glance back at Chart 24 will show that the fall in the last month of each of the three previous bear markets was particularly steep (the index fell 15%, 17% and 20% respectively). 25. How many months it took to square one if you bought early

9 months too early 6 months too early 3 months too early 1 month too early

1994-5

1997-8

2000-1

13 10 16 5

17 14 5 2

16 32 7 3

Source: HSBC, Bloomberg

Getting the timing right is particularly difficult because markets, by definition, bottom at the point of maximum bearishness. Naturally, that will be the moment when the worst news comes out. Markets are frighteningly good at bottoming at the point – often to the day – which, in retrospect, proves to be the turning-point. Barton Biggs’s recent book on markets during World War Two Wealth, War and Wisdom shows, for example, how the London stock market bottomed at the time of the Battle of Britain and the Berlin one peaked with the failure to capture Stalingrad, both with hindsight the key moments in the war.

07

The best recent example of this in Asia is SARS. The MSCI Asia ex Japan index bottomed, almost

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Equity Strategy Asia Pacific Fourth Quarter 2008

to the day, at the peak of deaths from the epidemic (Chart 26). 26. SARS deaths versus MSCI Asia ex Japan index

40

85

30

90

20

95

10

100

0

105

Mar-03 Apr-03 May -03 Jun-03 Jul-03 SARS deaths MSCI AEJ rel to w orld (RHS, inv )

Source: HSBC, WHO, Bloomberg

We include these remarks, at the risk of sounding whimsical, to remind investors that it can be dangerous to be too bearish when there is such a high level of fear around. Previous financial crises may give some guidance. The series of US bank failures in 1907 (described in The Panic of 1907, published last year by Robert Bruner and Sean Carr) has many similarities with the current situation. The financial crisis provoked an economic slowdown not, as more commonly, the other way around. Banks, brokers and companies failed because of links between them that no one had foreseen. But, most usefully as a lesson for the current situation, the New York Stock Market bottomed on November 4, 1907, the day that JP Morgan organised for US Steel to buy Tennessee Coal and Iron, which saved the largest Wall Street broker, Moore & Schley (we told you that the links were surprising). This proved to be the last in the series of bailouts organised by JP Morgan. The stock market rose by some 40% over the following year although the economy entered a nasty recession, with production falling 11% and unemployment rising from 2.8% to 8%. The lesson for 2008 would seem to be that, once the problems at the last troubled financial

institution are resolved – for example, by a government bail-out – this should mark the bottom for the stock market. That may take a while yet – we see unresolved problems in the US and Asia, and particularly in Europe. But, when the mood is as bleak as it is currently, it may be worth remembering that there will be an end to the crisis eventually – and that this will give a tremendous opportunity to buy stocks. This is why our index targets for Asia generally assume that markets will end the year down from their current levels. The falls may continue into next year, but once the bottom is reached the initial rebound is likely to be very strong. After the 1997-8 bear market, Asian stocks rose 46% in the six months after the bottom; after 2000-1 they rose by 47%. We can not predict the timing of the bottom with any certainty. But we do have confidence that, when it comes, stocks will rise strongly. Better be on your guard not to miss that opportunity.

But the rebound might be anaemic How long and strong will the rebound be? That is a different question altogether. The unresolved strains in the global financial system mean that it could be a stuttering rebound, with stock market returns after the initial bounce remaining quite poor for some time. Equally, there could be a double dip (as, remember, there was in 2002 and in 1981) with the economy failing to maintain the momentum of any recovery. Our biggest worry is that the US housing market could remain weak for years. The Case-Shiller index has, it is true, already fallen 21% from its peak in June 2006. But Case-Shiller index futures (the dotted line in Chart 27) are implying a further 15% decline, with prices not bottoming until the end of 2010. But a glance at the chart suggests that even the futures may be too optimistic. House

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Equity Strategy Asia Pacific Fourth Quarter 2008

prices rose by 226% between 2000 and 2006. The decline implied by futures would take them back only to the level of summer 2003. 27. S&P/Case-Shiller Composite 10 Home Price Index

Moreover, regulators’ laissez-faire attitude toward risk-taking by financial instructions will change. Simply put, many financial institutions allowed themselves to become excessively leveraged in

250

recent years. Chart 29 is a scary one. It shows the asset/equity ratio (forget BIS ratios – this is what

200

central banks will increasingly focus on) for groups of banks. The group that has recently got

150

into the most problems – US commercial banks – turns out to be relatively lowly leveraged, with

100

assets/equity only 12.9x at the end of last year, with this figure not having risen appreciably over

50 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: Bloomberg

We also fear that the US and European financial markets may struggle to provide the credit needed to fuel the economy for some time to come. In the US, loan growth has already slowed sharply, falling to 7% y-o-y in August (Chart 28). But that hides the fact that loans have not grown at all since the start of the year. It seems inevitable that by December loan growth will be in negative territory for the first time since 1993. Given the magnitude of banks’ risk aversion, loans could continue to shrink for some time.

the past few years. By contrast, large European banks are 37x leveraged, compared to 26x at the start of the decade, and US investment banks 29x. Much of that leverage is going to disappear from the system permanently. 29. Asset/equity ratios of large banks

40 30 20 10 0 00

01

Europe

02

03

US IBs

04

05 UK

06

07

US Comm

28. US bank loan growth y-o-y Source: HSBC, Bloomberg

25% 20%

Could Asia finally decouple?

15%

We include these comments on the US financial market to make one point. We wonder whether, once the dust has settled on the financial crisis, Asia might not start to decouple. If global portfolio investors worry about the poor outlook for bank lending in the US and Europe and about the likely multi-year sub-trend growth of US consumption, does not investment in Asia start to look relatively attractive? Asia does not, in general, have the same worries with its financial system. Asian banks have so far written off only

10% 5% 0% -5%

70

Source: CEIC

18

75

80

85

90

95

00

05

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Equity Strategy Asia Pacific Fourth Quarter 2008

USD24bn in credit costs over the past year or so – a miniscule proportion of the global total USD587bn. FX reserves remain strong. Governments generally have healthy budgets that will enable them to spend to mitigate the effects of global economic slowdown – most particularly China, which reported a budget surplus in the first half of this year of 9% of GDP. We do not suggest that this will happen immediately. While risk aversion is high, investors will withdraw money from high-beta emerging markets. US investors, in particular, typically bring their money back home in a crisis – even when the crisis is home made. That is why USD75bn has flowed out of Asia ex Japan equities (and another USD25bn out of Japan) since last August (Chart 30). Add in countries such as China and Singapore that do not report flow data, and we estimate total outflows of around USD125bn in just over a year. 30. Net foreign purchases of Asian equities since 2000

350 Japan

300

Asia ex -Japan

250 $ bn

200 150 100 50 0 2008

2007

2006

2005

2004

2003

2002

2001

2000

-50

Source: HSBC, Bloomberg

But some time next year perhaps, when growth is showing signs of bottoming and risk aversion is easing a little, developed country investors may again look to Asia as a more attractive long-term story than the US or Europe.

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Equity Strategy Asia Pacific Fourth Quarter 2008

Earnings  Current earnings forecasts are excessively optimistic  Analysts have revised down forecasts by 14% over the past six

months, but this is nothing like as much as peak-to-trough cuts in previous bear markets  We see perhaps another 34% downward revision to come

2008 EPS forecasts have been cut a little… Reacting to the constant negative news flow regarding the credit meltdown in the US, the equity market valuation entered into a correction phase. The 12-month forward PE of MSCI Asia ex Japan has come down almost to 10x, compared to 12x at the end of last quarter. However, earnings forecasts are much slower to reflect the downturn as analysts are still trying to assess the situation and probably waiting for next year’s guidance in the upcoming earnings season. Although all markets except Australia have revised down this year’s earnings forecasts (Table 5), these cuts, compared to the forecast six months ago, are still mostly single-digit. Only in Taiwan, Japan and the Philippines has EPS been revised down aggressively, by 25%, 17% and 15% respectively. Year-to-date, in Asia ex Japan analysts have cut their earnings forecasts by only 17%; they currently expect EPS to decline by 2% in 2008 (Table 2). Even after all the bad news in the financial markets, only Hong Kong, Japan, Malaysia, Singapore and Taiwan are expecting earnings to contract in 2008. These EPS forecasts are closer to reality than a few months ago, but revisions are very mild compared to the peak-to-

20

trough cuts of 68% in the 1997-98 bear market and 45% in 2000-01. In other words, we expect to see further downward revision in coming months.

…but 2009 EPS has even more room for decline Moreover, 2009 forecasts still look ludicrously over-optimistic. Analysts forecast 14% growth for Asia ex Japan overall, with even the slowest markets such as Malaysia still expecting to see 5% growth in 2009 (Table 2). The best markets such as Indonesia and India are expecting over 20% growth. Over the past few weeks, the 2009 forecast has showed some signs of being downgraded. China, in particular, has been cut to 17% from 19%, and Taiwan to 12% from 14%. However, these numbers still look too optimistic, and they are likely to come down quickly as the next earnings season starts. Therefore, even if the magnitude of the current downturn is somewhat less severe than previous bear markets in 1997-8 and 2000-1, earnings forecasts will likely to be cut by something like 45% from peak to trough. Therefore, earnings forecasts for 2009 could easily be cut by another 34% in coming months.

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Equity Strategy Asia Pacific Fourth Quarter 2008

1. 12-month forward EPS growth vs MSCI Asia ex Japan (%) 50

2. Consensus forecast for EPS growth 80% 60%

40 30

40% 20%

20

0% -20%

10

-40% -60%

0 1994 1996 1998 2000 2002 2004 2006 2008 EPS grow th

MSCI AEJ index y -o-y (RHS)

Australia China Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand Asia ex-Japan Asia Pacific

2007

2008

2009

3.9 32.4 44.0 11.2 47.2 3.6 8.2 43.8 -2.6 11.6 24.8 -35.9 12.4 6.1

9.1 13.3 -26.1 19.3 16.3 -4.0 3.5 -12.6 0.8 -3.4 -20.2 114.1 -1.9 -2.7

17.1 16.6 8.3 23.2 29.0 10.3 14.8 4.9 14.1 7.1 12.1 7.2 14.0 16.2

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

40

70

30

60

20

50

10 40

0

30

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Asia ex -Japan

2008

2007

2006

Source: I/B/E/S, HSBC

5. Revisions to 2008 EPS forecasts by country

AU TH CN IN SG MY ID HK JP PH KR TW AEJ AP

2005

Upgrades as % ot total

Source: I/B/E/S, HSBC

Country

2004

2003

2000

-30

2002

20

-20

2001

-10

vs 3M ago

Rank

0.7% -0.1% -2.0% -2.1% -2.2% -2.9% -4.5% -4.6% -6.6% -6.9% -9.2% -22.5% -12.6% -10.0%

1 2 3 4 5 6 7 8 9 10 11 12

6. Revisions to 2008 EPS forecasts for Asia Pacific sectors vs 6M ago Rank 1.6% -3.0% -3.5% -3.4% -6.2% -2.5% -7.1% -1.0% -16.5% -15.3% -7.1% -25.4% -14.2% -18.7%

1 4 6 5 7 3 8 2 11 10 9 12

Sector Health care Energy Telco Industrials Cons. stap Cons. discr Materials Financials IT Utilities

vs 3M ago

Rank

4.3% -2.8% -3.9% -4.4% -5.4% -6.2% -9.8% -11.9% -19.2% -66.8%

1 2 3 4 5 6 7 8 9 10

vs 6M ago Rank -27.2% -5.7% -7.4% -8.8% -10.1% -21.6% -16.1% -20.4% -23.2% -81.5%

9 1 2 3 4 7 5 6 8 10

Source: I/B/E/S, HSBC

Source: I/B/E/S, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Valuation  Asia ex Japan PE is 10.3x, close to bottom of its historical range  PB is still 1.7x, not near the typical 1.2x bottom yet, but a higher

trough ROE might justify a PB bottom of 1.4-1.5x  Valuation is not at rock-bottom yet, but perhaps not too far away

Forward PE close to bottom

But bottom might be close

Valuations are starting to look positively cheap. The 12-month forward consensus PE for MSCI Asia ex Japan is now 10.3x, approaching the bottom of its long-term range (Chart 1). In 2003, PE got down to 9x, but in the 1997-98 Asian Crisis, its low was 10.8x.

However, looking at PB alone misses out the fact that investors might be more willing to pay a higher premium over book value now. Return on equity (ROE) peaked at 15% before the Asian Crisis, and then at 14% at the height of the TMT bubble in 2000. This time, however, forecast ROE peaked at 18.5% and has since come back only slightly to about 17%. PB might not go all the way down to the previous bottom because ROE has structurally improved. This would suggest that the bottom for ROE may not be 9% as in 1998 or 11% as in 2002, but perhaps 3 or 4 percentage points higher, i.e. 14-15%. If that is the case, then PB may not fall to 1.2x as at the bottom of previous bear markets, but maybe to only 1.4x or 1.5x. In this case, stocks may only have another 15-20% to fall before they hit bottom.

In chart 3, we plot the 2008 PE versus the average EPS growth forecasted for 2007-09. On a PER/growth basis, India looks expensive while China, Thailand and Indonesia are cheap relative to the rest of Asian markets.

PB not yet low enough… Price to book (PB) for Asia ex Japan has bottomed fairly consistently at around 1.2x. It is currently at 1.7x, so it appears to have about 30% to fall before hitting previous lows. Unlike PE, most markets in the region are still at least 15% away from the previous low reached in the 2000-3 bear market. Japan is the only exception. Its PB is now trading at the previous low of 1.2x. (Chart 2).

In chart 4, we plot the PB versus ROE/COE to see how much premium investors are paying for the value companies are creating over their cost of equity. On this basis, India looks expensive again while China and Australia look cheap. In conclusion, stocks are not at rock-bottom valuations yet, but they may not be that far away.

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Equity Strategy Asia Pacific Fourth Quarter 2008

1. 12-month forward PE – Asia ex Japan

2. Current forward PE versus historical average PE now

Average 2001–

% diff

Average 1993–

% diff

China HK India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Japan Australia

9.4 11.8 12.2 8.6 9.5 11.2 12.4 10.8 11.1 7.9 12.4 10.0

13.0 16.1 13.9 9.1 9.0 14.2 14.1 15.1 13.5 10.6 19.2 14.7

-28% -26% -13% -6% 6% -21% -12% -28% -18% -26% -36% -32%

13.3 14.9 13.6 12.9 11.2 16.3 14.9 16.6 18.2 21.2 31.8 15.1

-29% -21% -11% -33% -15% -32% -17% -35% -39% -63% -61% -33%

Asia ex-Japan Asia Pacific

10.3 11.5

12.4 16.1

-17% -29%

14.6 26.0

-30% -56%

20 18 16 14 12 10 8 2001 2002 2003 2004 2005 2006 2007 2008 Forw ard PE - Asia ex -Japan Source: Bloomberg. I/B/E/S, HSBC

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

PE 2008

3. PE versus average EPS growth 2007-09

14 13 12 11 10 9 8 7 6

4. PB versus ROE/ COE 3.5

PH JP SG AP HK MY TW AEJ AU KR

IN

PBR

ID

3.0

IN

2.5

CH

PH

ID

2.0

TH 1.5

0

10 20 EPS growth 2007-9

30

40

JP

ROE/COE

HK

1.0 0.8

Source: I/B/E/S, HSBC

AU

CH

MY SG TW KR TH 1.3

1.8

2.3

2.8

3.3

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

5. Dividend discount model

Inputs DPS year1 EPS year 1 EPS year 2 Growth in stage 2 (%) No. of years of excess growth Perpetual growth rate (%) Payout ratio now (%) Payout ratio at end stage 2 (%) COE (%) Result MSCI index now Fair value Under/over valued (%)

SG

AU

CH

MY

TW

IN

HK

ID

TH

JP

PH

VN

59.6 120.1 131.8 9 10 6.0 49.6 50.0 9.3

48.8 91.6 98.6 7 10 6.0 53.2 50.0 9.2

1.5 4.5 5.2 13 12 6.0 33.6 40.0 11.3

18.6 32.6 35.1 9 10 6.0 57.1 50.0 10.3

13.8 20.2 23.5 6 10 6.0 68.4 50.0 9.8

8.4 42.6 49.7 12 15 6.0 19.7 40.0 10.8

318.6 665.1 753.3 6 10 6.0 47.9 50.0 9.3

110.7 276.5 324.1 15 15 6.0 40.0 45.0 15.3

13.4 30.5 33.2 10 10 6.0 43.9 45.0 12.8

14.8 55.4 62.0 6 10 5.0 26.6 40.0 8.3

21.5 40.6 45.6 10 10 6.0 52.9 45.0 11.3

12.3 38.6 46.3 15 20 6.0 32.0 40.0 16.8

1,404 1,002 2,296.0 1,516.5 -38.9 -34.0

49 69.0 -29.5

377 486.2 -22.5

234 301.5 -22.3

537 8,610 2,580 678.5 10,823.7 3,027.5 -20.8 -20.4 -14.8

259 271.7 -4.6

727 753.3 -3.5

512 518.1 -1.1

470 337.2 39.5

Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Supply and demand  Korea has seen the biggest outflows in 2008, but funds are now

so underweight that selling pressure should abate somewhat  Outflow in other Asian markets continues to accelerate  Equity issuance has also dwindled

USD31bn of foreign money left Asia in 3Q08 2008 has not been a good year for foreign fund flows. The cumulative net foreign buying since 2000 has decreased from USD441bn to USD410bn, or 7%, in Asia. If we exclude Japan, which had USD23bn inflow in Q2, the outflow is even more pronounced (Chart 1). Year-to-date, foreign investors have been net sellers in all Asian markets except Indonesia. Most notably, USD29bn worth of equity has been sold by foreign investors in Korea to endSeptember – equivalent to the total amount of selling in 2007 (Table 2). Large foreign funds have now become deeply underweight: the main global asset management companies have only 912% of equity assets of their Asia ex Japan funds in Korea, versus an MSCI benchmark of 20.4%. It seems unlikely that fund managers would be prepared to go much more underweight than this and thus the pressure from further foreign selling in Korea should ease. Other than Korea, all major Asian markets saw a net inflow in 2007 but have reversed this trend in 2008 so far. Data on Taiwan illustrates this point well. In 2007, foreigners bought a total of USD2bn worth of stock in Taiwan. However, they have sold over USD9bn worth of stocks in 2008

24

year-to-date. As of 24 September, foreign investors are holding USD152bn worth of Taiwanese equities. With weakening export demand and lingering concerns around the financial sector worldwide, foreign investors are likely to seize any further chance to take profits. Thailand has a similar situation as Taiwan, experiencing a large outflow of USD4bn year-todate, after an inflow of USD1.6bn in 2007 that was triggered by expectations that the political turmoil might end. When it did not, foreigners started to sell again. India has also seen foreign selling since January, with total outflows for the year-to-date reaching USD9bn.

Equity issuance difficult in current environment Unsurprisingly, 2008 has not been a good year for equity issuance either. Table 3 compares the annualised 2008 year-to-date issuance amount to 2007 total issuance. All markets except Thailand experienced a significant drop-off in equity issuance in 2008 (and Thailand’s has stayed flat only because 2007 was also poor). Equity issuance has largely ground to a halt since early summer. Only Australia has seen a healthy amount of deals so far this year.

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Equity Strategy Asia Pacific Fourth Quarter 2008

1. Cumulative net buying by foreign investors since 2000

2. Foreign net buying by markets 2007-8 (USDbn)

450

USDbn

350 250 150 50

Japan

2008

2007

2006

2005

2004

2003

2002

2001

2000

-50

Asia ex -Japan

Source: Bloomberg, HSBC

JP

TW

KR

TH

IN

ID

Sep-07 Oct-07 Nov-07 Dec-07 2007 Jan-08 Feb-08 Mar-08

-4.3 2.0 -3.1 -2.9 43.5 -3.3 -3.5 -13.0

1.9 1.6 -4.6 0.8 2.1 -1.0 3.1 -0.6

-2.1 -2.3 -7.3 -2.6 -29.4 -9.0 -2.1 -3.1

0.1 0.4 -1.2 -0.5 1.6 -1.2 1.0 -0.3

4.7 4.4 -1.2 1.2 17.8 -4.4 1.2 0.0

0.3 0.1 0.1 0.0 3.2 0.1 0.2 -0.3

Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 2008 Y-t-d

8.0 10.8 4.5 -4.6 -1.5 -4.8 -7.4

-1.0 0.4 -3.8 -3.6 -0.7 -2.2 -9.3

-1.2 0.9 -4.6 -4.8 -2.8 -2.1 -29.0

0.0 0.0 -1.1 -1.1 -0.3 -0.7 -3.7

0.2 -1.1 -2.5 -0.2 -0.5 -1.3 -8.5

0.2 0.4 0.0 -0.1 0.0 0.3 0.8

Source: Bloomberg, HSBC

3. Total equity issuance by market 2005-8

4. Net inflows into Japanese equity investment trusts

23.3 53.1 20.7 24.3 19.5 10.1 3.1 6.1 0.6 10.1

13.4 11.9 3.8 6.0 4.5 2.4 0.5 0.5 0.6 2.4

-30% -73% -78% -70% -72% -71% -82% -89% 23% -84%

AEJ AP

86.0 145.3

132.1 219.6

158.0 177.6

43.5 48.0

-66% -67%

Notes: 2008 Y-t-d data up to 25 Sep 2008' * = annualized Source: Bloomberg, HSBC

300

(JPYbn)

200 100 0 -100 -200

Stock IT Source: IT association, HSBC

5. Net inflows into Korean equity-related investment trusts

6. Net inflows into Indian mutual funds

18,000

1000 800 600 400 200 0 -200 -400 -600

Net inflow into equity related inv estment trust

2008

2007

2006

2005

2008

2007

2006

2005

2004

2003

2002

2001

-2,000

2004

3,000

2003

8,000

2002

13,000

(INRbn)

2001

(KRWbn)

Source: CEIC, HSBC

2008

30.8 69.0 20.2 12.2 56.6 11.3 1.1 5.2 2.9 11.3

2007

15.5 28.5 10.1 10.1 43.9 15.8 1.3 3.7 1.2 15.8

2006

AU CH HK IN JP KR MY SG TH TW

2005

2008* v 2007

2004

2007 2008 Y-t-d

2003

2006

2002

2005

2001

(USDbn)

Mutual funds net flow Source: CEIC, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Politics and risk  Thai political unrest is likely to continue  New Japanese Prime Minister Taro Aso will probably call an early

election but this is unlikely to resolve the stalemate  The opposition party in Malaysia is gearing up to seize power

Politics remains an important theme for markets A lot of things happened in Asian politics during 3Q08. Political unrest added downside risk to the financial markets. Most notable were the street protests in Thailand. On August 25, protesters accused Prime Minister Samak’s government of corruption and being a proxy for ex-Prime Minister Thaksin. Protestors demanded Samak’s resignation by occupying the Prime Ministerial compound and various airports, causing tourists and investors to panic. MSCI Thailand tumbled 24% during the quarter. The conflict was finally resolved on September 9 when Somchai Wongsawat, the People Power Party’s deputy leader, took office. Unfortunately, Prime Minister Somchai now also faces an investigation into his holding in an internet service provider that has contracts with a stateowned telecom service provider. If found guilty, Somchai would be disqualified from serving as the prime minister. Thai political risk is likely to remain a key concern among foreign investors. In Japan, Prime Minister Fukuda surprisingly stepped down because of the political deadlock that made it impossible for him to implement policies. The ruling Liberal Democratic Party chose Taro Aso to be the third prime minister in less than two years. Well known for his hawkish views, Prime Minister

26

Aso urges Japan to be more assertive in taking a global role; this causes concern in China and the US that it will be harder to forge regional agreements in future. Meanwhile, the opposition party controls the Upper House of Parliament, which will continue to make it difficult for the Prime Minister to pass any legislation. This unstable situation is unlikely to be resolved by a general election that may be called late this year or in early 2009. Taiwanese politics have, for once, been relatively uneventful. The next key milestone is the second round of negotiations with Beijing that is scheduled to take place in November. There are hopes that these may reach agreement on crossstrait cargo flights and mainland investment in Taiwanese stocks. In Malaysia, opposition party leader Anwar Ibrahim continues to make noise on his ability to topple current Prime Minister Abdullah Ahmad Badawi, who has failed to implement key pledges such as ending corruption and boosting the independence of the judiciary. Anwar has so far failed to call the no-confidence motion he threatened for September. But, within the ruling party, frustration with Abdullah is rising and he may be quickly replaced by his deputy Najib Razak. One way or the other, the situation looks likely to resolve itself over the next few months.

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Equity Strategy Asia Pacific Fourth Quarter 2008

1. Average sovereign credit rating – Asia ex Japan

2. S&P long-term foreign currency credit ratings

17.0 16.5 16.0 15.5 15.0

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

14.5

Av erage credit rating

Latest rating

Date

Previous rating

AAA AAA AA+ AA AAA+ A ABBB+ BBBBBBBBB

Feb-03 Mar-95 Jul-08 Apr-07 Dec-02 Jul-08 Jul-05 Oct-03 Oct-06 Jan-07 Jul-06 Jan-05 Sep-06

AA+ AA+ AA AAAA A ABBB+ BBB+ BB+ B+ BB

AU SG HK JP TW CH KR MY TH IN ID PH VN Source: Bloomberg

Source: Bloomberg. HSBC

3. Spread on Asian USD bonds versus MSCI Asia ex Japan

4. Government approval ratings

750

100

650

150

80 70 60 50 40 30 20 10 0

200

550

250

450

300

350

350

250

400

150

450

2001 2002 2003 2004 2005 2006 2007 2008 MSCI Asia ex J

ADBI spread (RHS, inv erse)

Source: I/B/E/S, HSBC

Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 KR

TW

AU

JP

HK

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

5. Political snapshot of Asia Pacific markets Country

Head of government

Latest approval rating Next significant political events

Australia China Hong Kong India

Kevin Rudd (Prime Minister) Hu Jintao (President) Donald Tsang (Chief Executive) Manmohan Singh (Prime Minister)

54% n/a 52% 77%

Indonesia

Susilo Bambang Yudhoyono (President) 21%

Japan Korea Malaysia Philippines

Taro Aso(PM) Lee Myung bak Abdullah Ahmad Badawi (PM) Gloria Macapagal-Arroyo (President)

54% 24% 50% 22%

Singapore Taiwan Thailand

Lee Hsien Loong (PM) Ma Ying-jeou (President) Somchai Wongsawat (PM)

25% 40%

Consensus view of result

Federal Election to be held in 2010 Next Presidential election by mid - March 2013 Chief Executive election to be held in 2012 Parliamentary election in May 2009 The ruling Congress Party and opposition BJP have equal chance to form coalition govt Presidential and legislative elections April 2009 Close call between SBY and Megawati Soekarnoputri for president Possible general election by early 2009 Hard to call Parliamentary election December 2012 Parliamentary election by 2013 Presidential election 2010 Gloria Macapagal-Arroyo to stay in power till 2010 Parliamentary election by 2010 Ruling party to win next election Presidential election by March 2012 Parliamentary election by Dec 2011

Source: Various polling agencies and media, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

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Equity Strategy Asia Pacific Fourth Quarter 2008

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Country profiles

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Equity Strategy Asia Pacific Fourth Quarter 2008

Japan (neutral)  Performance of Japanese stocks depends on external factors  Risks: further downward earnings revisions and a policy shift

towards fiscal spending  Valuations have not yet hit historical lows but downside risk is

limited

Rudderless boat on rough seas In the current environment, Japan looks relatively stable as a developed market. So far this year, the stock market has performed well compared to other Asian countries (although one reason was that it underperformed last year). However, Japan is a highly cyclical market, since its main drivers are external: 1) corporate earnings are highly dependent on the global economy, and 2) the performance of the stock market is largely reliant on foreign buying.

We expect the Japanese economy to remain in recession and to experience only a moderate recovery after bottoming in April-June 2009. Corporate earnings forecasts continue to be revised down. The latest Japan Company Handbook published on 16 September cut aggregate operating profit forecasts for exfinancials companies by 3.3pts to -7.1% for the fiscal year ending March 2009. Many of our analysts expect companies to lower their forecasts in the coming two months, since companies tend to revise full-year forecasts in October and

Key financial and economic forecasts 1. Returns (%, USD)

3-month 6-month 12-month 24-month

2. Economic forecast MSCI Japan

TOPIX

-18.3 -18.4 -28.3 -24.2

-17.6 -12.6 -32.7 -32.5

4. Q3 2008 sector performance (%)

Defensives Telecom Financials Cyclicals Technology Energy

GDP growth (%) Consumer prices (%) JPY/ USD Short interest rate (%) Long interest rate (%)

3. Valuation 2008

2009

0.8 1.4 115 0.6 1.4

0.6 0.9 118 0.6 1.6

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

13.2 1.2 2.2 4.0 5.6

12.0 1.1 2.3

2008

2009

-4.0 9.0 1.6 0.0

10.3 9.1 1.9 0.0

5. Earnings (%)

Absolute

Relative

-4.4 -7.4 -14.2 -23.2 -23.7 -27.9

17.3 14.4 7.6 -1.4 -1.9 -6.2

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

30

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Equity Strategy Asia Pacific Fourth Quarter 2008

November when they announce interim results. Political paralysis is unlikely to end in the short term. Japan’s new Prime Minister Taro Aso is likely to call a general election late this year or early in 2009, after passing the JPY1.8trn supplementary budget for economic stimulus that was proposed by his predecessor Fukuda. However, the outcome of the election is too close to call. There are three scenarios: 1) the ruling party narrowly wins – this causes further political turmoil as it won’t be able to pass legislation due to the split parliament, 2) DPJ wins – this mends the split parliament situation but implementation of DPJ policy remains uncertain, and 3) neither LDP nor DPJ wins the majority – this potentially triggers political realignment. Furthermore, Japan is likely to shift away from structural reform. No matter which party wins, the new prime minister is likely to increase fiscal spending and postpone the FY2011 target for achieving a primary balance. Valuations have not hit historical lows yet. For example, 12-month forward PE is currently 12.4x,

look to have limited downside risk. Current PB of 1.3x is close to the low of 1.1x hit in spring 2005.

Sectors and stocks We keep a cautious investment stance and stay fairly defensive. Our biggest overweights are telecoms and healthcare. KDDI (9433) is likely to benefit from the reduction in competitive intensity in the mobile business. We would recommend investors to focus on large caps with strong balance sheets. We prefer sectors and companies that will enjoy structural growth, for example, games companies. The utilities sector is defensive and was the best performing sector in Q3, but we remain neutral since the sector looks particularly expensive after earnings forecast revisions and a share price rally since mid-May. We continue to avoid consumer discretionary and technology stocks, where we expect more downward earnings revisions due to a slowdown in global demand.

6. Inflection points

still above the historical low of 11-12x hit in March. In addition, we estimate actual PE would

How much the economy slows

be around 15x, since analysts are still too optimistic with their forecasts, especially for next

Size of fiscal stimulus package likely to be implemented by next PM

fiscal year. From a PB point of view, Japan does

Outcome of Lower House election (probably late 2008 or early 2009)

Companies to revise down earnings forecasts after half-year results Source: HSBC

7. Sector weightings and Stock screening Sector

Sector weightings

Stocks rated Overweight

Consumer discretionary

underweight

Toyota Boshoku Corp, Isuzu Motors, Sky Perfect JSAT Honda Motor Corp

Consumer staples Energy Financials

neutral neutral underweight

Healthcare Industrials

overweight neutral

Technology Materials Telecoms Utilities

underweight underweight overweight neutral

Sompo Japan Insurance Inc, Mitsui Sumitomo Group Hol Olympus Nippon Electric Glass Co, Yokogawa Electric Corp, Nikon Corp. Konami Corporation,Nintendo Co., Ltd. Asahi Glass Co., Ltd., JFE Holdings, Nippon Steel KDDI Corp, NTT

Stocks rated Underweight

Mitsubishi UFJ FINL, Sumitomo Mitsui Financial

Tokyo Electron

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Dragged down by cyclicals and tech

120

 MSCI Japan is down 24% since the start of the year, but outperformed MSCI Asia Pacific by 26%

100

 In Q3, MSCI Japan is down 13.8% but is the third best performer in AsiaPacific  Worst performing sectors: energy and technology

80 60 Sep-07

Nov -07

Jan-08

Mar-08

Cy clicals Financials Main index

May -08

Jul-08

Defensiv e IT

Sep-08

Energy Telecoms

Source: HSBC

10. Economy

11. Forecasts cut further

Consensus forecast on Real GDP growth

3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5%

 Consensus forecasts for real GDP growth have slipped to +0.9% in 2008 and +0.9% in 2009  Our economist expects the Japanese economy to remain in recession for another two quarters due to the weak US economy

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

Sep-07

Mar-07

Dec-06

Jun-06

2006

Sep-06

Mar-06

Dec-05

Sep-05

Jun-05

 HSBC revised down real GDP growth forecasts to +0.8% and +0.6% respectively for 2008 and 2009

2009

Source: Consensus Economics, HSBC

12. Leading indicators

13. Getting worse  Our Economic Performance index has continued to drop since summer 2007

220

1200

170

1000

 External demand continues to deteriorate. Export volume fell 3.1% y-o-y in August

800

 Core machinery orders were down 3.9% m-o-m in July. Our economist expects further decline towards year-end on slowdown in the global economy

120 70

600

20 -30

400

2002

2003

2004

2005

2006

JP Econ Performance Index

2007

2008

MSCI JP (RHS)

Source: Bloomberg, MSCI, HSBC

14. Earnings

15. Earnings growth to turn negative in 2008

Japan

200 150

 The September edition of Toyo Keizai Japan Company Handbook revised down operating profit forecasts for ex-financials companies to -7.1% from -3.8% in the June edition

% y-o-y

100 50

 The biggest downward revisions came from the chemicals, autos and electric machinery sectors

0 -50 -100 -150 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Source: I/B/E/S, HSBC

32

 The consensus forecasts 4% decline in EPS for MSCI Japan in 2008, followed by 14% recovery in 2009

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. Expect more downward revisions in October- November  Consensus EPS forecasts for 2008 have been revised down over the past eight months

80 60 40 20 0 -20 -40

 We expect further downward revisions to come in October-November, when companies announce their first-half results for FY2008

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

 Compared to three months ago, recurring profit forecasts have been revised down in 22 out of 33 TOPIX sectors

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

18. Valuation

19. Still above historical low  12 month forward PE is currently 12.4x, low compared to history but above the historical low of 11-12x hit in March…

80x 70x 60x 50x 40x 30x 20x 10x

 …in addition, we estimate actual PE is around 15x after earnings have been revised down further

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

 Current PBR of 1.3x is also cheap but still above the historical low of 1.1x hit in 2005

12-month fw d PE Source: HSBC

20. Sector valuation

21. Utilities sector looks particularly expensive

12-month fw d PE

50x

5-y ear PE mean

 Utilities looks particularly expensive with combination of stock outperformance and downward revision in earnings

40x

 Except utilities, all sectors are trading below their five-year mean

30x

 Healthcare, energy and industrials are trading in-line with Pan-Asian peers

20x 10x

als st r i

ls

rg y

du In

En e

ate

ria

is c r M

s

lco

ns .d

Co

Te

IT

nc ial

na Fi

ca re

tap

alt h

He

ns .s

Co

Ut ilit ie

s

0x

Source: I/B/E/S, HSBC

22. Foreign flows

350 300 USDbn

23. Foreigners turned net sellers  Foreigners have turned net sellers since end-June, having sold a net JPY1.4trn after buying net JPY2.7trn between April and late June

250

 Problem of Japan is an absence of domestic investor base. Individuals only buy when stock market falls

200

 Domestic stock funds have largely seen net outflows since November 2006

150 100 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 Jun-08 Sep-08

50

Source: Bloomberg. HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Australia (underweight)  Australia is superficially attractive as a cheap developed market  But PE of 10.0x is distorted by overly optimistic earnings forecasts  …and both the economy and banking sector are fragile

More risks than are apparent Australia might seem a natural overweight in an environment of global uncertainty. As a developed market, it had indeed outperformed MSCI Asia Pacific until September, although it is now down 34% in USD terms. Valuation-wise, too, it looks cheap, with a 12-month forward PE of 10.0x – the lowest level since the early 1990s. It is supported by steady buying from a welldeveloped superannuation (pension) system. We are not convinced, though, that Australia is going to prove so defensive this time. For one, there are structural problems: Australia’s current account deficit is the fourth largest in the world in

absolute amount, behind only the US, UK and Spain. That is one reason why the Australian dollar fell 15% in Q3. Australia’s banks have also been unusually active in overseas markets, not least in asset securitisation. Add to that an overheated property market at home, now showing signs of weakness, and Australian banks are likely to have to write off more than the tiny amounts they have so far. Moreover, the earnings outlook is unlikely to be as good as analysts are forecasting – which suggests that 10.0x forward PE may not be meaningful. Analysts are looking for 35% net profit growth in the fiscal year ending June 2009, and 14% for June 2010.

Key financial and economic forecasts 1. Returns (%, USD)

2. Economic forecast

MSCI Australia S&P/ ASX 200

3-month 6-month 12-month 24-month

-27.3 -25.3 -37.4 -5.1

-11.8 -14.0 -30.0 -10.7

4. Q3 2008 sector performance (%)

Technology Financials Defensives Telecom Energy Cyclicals

GDP growth (%) Consumer prices (%) USD/ AUD Short interest rate (%)

3. Valuation 2008

2009

2.7 4.5 0.86 7.2

3.0 3.5 0.74 6.0

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

11.6 2.0 5.3 5.5 10.1

9.9 1.9 5.6

2008

2009

9.1 17.6 3.6 285.2

17.1 19.1 4.0 282.5

5. Earnings (%)

Absolute

Relative

-17.0 -17.9 -18.1 -19.0 -31.8 -38.5

4.8 3.9 3.6 2.8 -10.0 -16.7

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

Commodities prices versus MSCI Australia

500

CRB (LHS)

450

1300

MSCI AU

1100

400

900

350

700

300

500

250 200

300

150

100 90

92

94

96

98

00

02

04

06

08

Source: HSBC, Bloomberg

As always with Australia, earnings will be very dependent on commodity prices. For the current fiscal year, three-quarters of the growth in profits comes from just the two largest resources companies. We do not expect metals prices to collapse (partly because we see Chinese demand remaining strong). But an increase in supply, especially in iron ore and copper, means that prices may well continue to soften somewhat over the next 12 months. A combination of weaker commodities profits (even an outright decline), more bank provisioning, and a slowdown in earnings from consumer-oriented companies, means that profit forecasts may have to be cut significantly. The Australian stock market has long shown a close correlation with commodity prices – it is unlikely to rebound in a sustainable way until commodities also find a bottom.

Meanwhile, the economy shows signs of slowdown. GDP grew only 0.3% q-o-q in Q2. The consensus has cut this year’s growth forecasts to 2.6% (from 3.6% in January). On the positive side, this will push the Reserve Bank to cut rates again – it took them down 25bps in September. We forecast a further 150bps of easing over the next 12 months. This will eventually help the economy to bottom out – but not yet.

Sectors and stocks We remain most wary on the financials sector, which will continue to be under strain from the slowing economy and from overseas exposure. We are also underweight on the resources sector; we think the consensus remains too sanguine about the outlook for iron ore prices, in particular, next year. We are also cautious on consumer discretionary stocks: not only do they have significant exposure to the US, but there are growing signs of weakness for Australian consumption too.

6. Inflection points

How quickly Reserve Bank cuts rates How much further commodities prices fall Further credit-related write-offs from the banks Source: HSBC

7. Sector weightings and Stock screening Sector

Sector weightings

Consumer discretionary Consumer staples Energy Financials Healthcare Industrials Technology Materials Telecoms Utilities

Underweight Underweight Neutral Underweight

Stocks rated Overweight

Stocks rated Underweight

BlueScope Steel

Lihir Gold

Underweight Underweight Neutral

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Slight outperformance  MSCI Australia is down 34% y-t-d, underperforming Asia Pacific by 3%

150

 Energy is the only sector to rise y-t-d, up 9%

130

 Biggest declining sectors y-t-d were industrials (-30%) and financials (-29%)

110 90 70 50 Sep-07

Nov -07

Jan-08

Mar-08

Cy clicals Financials Main index

May -08

Jul-08

Defensiv e IT

Sep-08

Energy Telecoms

Source: HSBC

10. Economy

11. Growth downgraded

Consensus foreast on Real GDP growth

4.0%

 The consensus real GDP growth forecast for 2008 has been cut to 2.6%, from 3.6% at the start of the year  The consensus forecast for next year is also 2.6%

3.5%

 HSBC forecasts 2.7% growth this year and 3.0% growth next

3.0% 2.5%

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

Sep-07

Mar-07

Dec-06

Jun-06

2006

Sep-06

Mar-06

Dec-05

Sep-05

Jun-05

2.0%

2009

Source: Consensus Economics, HSBC

12. Leading indicators

13. Weakening economy will lead to rate cuts

35

1500

25

1300

15

1100

5

900

-5

700

-15

500

2002

2003 2004 2005 2006 AU Econ Performance Index

 Australian economic data has deteriorated sharply in the past few months  The HSBC Economic Performance Index shows that net 10% of indicators have declined over the past month and net 4% have declined over three months  In particular, labour market indicators have begun to weaken, which makes it likely that the RBA will cut rates further.

2007 2008 MSCI AU (RHS)

Source: Bloomberg, MSCI, HSBC

14. Earnings

15. Earnings forecasts still optimistic Australia

% y-o-y

40 30

 This year the strongest growth is expected from energy (+66%) and healthcare (+20%)

20

 In 2009, strongest growth is forecast for healthcare (22%) and materials (16%)

10 0 -10 1992 1994 1996

Source: I/B/E/S, HSBC

36

 Consensus expects Australian EPS to grow 9.1% in CY2008 and 17.1% in CY2009 on a calendarised basis

1998 2000 2002

2004 2006 2008

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. One of the few countries with upward earnings revisions

20

 Over the past three months, the Australia 2008 EPS forecast has been revised up by 7% and the 2009 forecast by 15%

10

 For the current year, the biggest upward revision in the past three months has been in financials (-9%) and biggest downward revision in materials (+17%)

0

 For next year, the biggest revisions have been industrials (-8%) and materials (+21%)

-10

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

-20

Australia 6-month earning momentum

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

18. Valuation

19. Close to historical lows  12-month forward PE has fallen to 10.0x

21x 19x 17x 15x 13x 11x 9x 7x

 That is far below the long-run average of 15.1x, and even below the low of 12.9x that Australia reached in the 2001-3 bear market

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

 Price/book has fallen to 2.2x. In the last bear market it got to 1.7x

12-month fw d PE Source: HSBC

20. Sector valuation

21. Cheap across the board

12-month fw d PE

25x

5-y ear PE mean

20x

 Most sectors are trading at significantly lower multiplies than the average over the past five years.  Cheapest sectors relative to history are materials (7.8x v. 12.2x) and consumer discretionary (11.6x v. 17.8x)

15x

 Only energy (18.6x v. 16.8x) and utilities (17.5x v. 16.9x) are expensive relative to history

10x 5x

Te lco Co ns .d is c r Fi na nc ial s M ate ria ls

IT

st r i C o al s ns .s tap

ies In

du

y

Ut ilit

er g En

He al t h

ca re

0x

Source: I/B/ES, HSBC

23. How scared are the local investors?  Australia does not provide timely foreign flow data, so we rely on data for global mutual funds from EPFR

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0

 This shows that foreigners were big sellers in Q1, but have sold only a small amount more since then  Domestic investors, especially superannuation funds, provide some support – but they are becoming more risk averse with the losses on asset-backed securities holdings

Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08

USDbn

22. Foreign flows

Source: EPFR, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Korea (underweight)  Korea could be about to face its own credit problems…  …at the same time that slowing exports dent GDP growth  We lower our recommendation to underweight

Credit risk rises The Korean market looks increasingly risky. Debt in the household and SME sectors has built up to dangerous levels. Household debt is now 88% of GDP, up from 75% after the bursting of the 20023 credit card bubble. Corporate debt has risen to 230% of GDP. What makes this particularly worrying is that the housing market is starting to experience difficulties. Prices of apartments in the top locations in Seoul have fallen 15% y-o-y and the number of unsold units has reached 200,000, according to industry sources. This presents a significant risk for small financial institutions,

which have financed as much as 40% of recent real estate developments. Construction companies have already started to go bankrupt, and delinquency rates on real estate project loans may be as high as 10%. In an environment of high risk aversion, the last thing Korea can afford is a credit crisis of its own. But one may be in the works. Meanwhile, the economy remains very exportsensitive. Exports have so far held up well. As the chart below shows, exports have grown on average 24% y-o-y over the past three months. But a recession in the US and a slowdown in China are likely to cause Korean exports to slow sharply over coming months. That should negatively impact consumption and capex growth,

Key financial and economic forecasts 1. Returns (%, USD)

3-month 6-month 12-month 24-month

2. Economic forecast MSCI Korea

KOSPI

-24.3 -29.7 -42.7 -18.3

-13.5 -14.9 -25.6 5.6

4. Q3 2008 sector performance (%)

Telecom Defensives Cyclicals Financials Technology Energy

GDP growth (%) Consumer prices (%) KRW/ USD Short interest rate (%)

2. Valuation 2008

2009

3.9 4.7 1039 5.4

3.4 3.5 1100 5.0

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

10.6 1.3 0.3 10.0 9.3

9.2 1.2 0.3

2008

2009

3.5 12.3 2.6 0.0

14.8 12.6 2.6 0.0

5. Earnings (%)

Absolute

Relative

-9.5 -15.7 -25.0 -25.1 -26.4 -28.4

12.3 6.1 -3.3 -3.3 -4.6 -6.6

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

too. HSBC’s economists have cut their forecasts for next year’s real GDP growth to 3.4% from 3.7% previously. This is much more gloomy than the consensus, which still forecasts 4.3%. Korean export growth and stock index movement

40%

100%

20%

50%

0%

0%

new president has been quietly announcing new measures over the past few weeks. These include a new house-building programme to help construction companies, corporate tax cuts and increased infrastructure spending. So far, he has skirted around more controversial issues (such as labour reform) but these could come if there is progress on less controversial changes.

-40%

2008

2006

2004

2002

2000

1998

1996

1994

-20%

1992

Sectors and stocks -50% -100% Korean ex ports y /y (LHS)

KOSPI y /y (RHS)

Source: HSBC, Bloomberg

Of course, some of the bad news is in the price. MSCI Korea is down 40% y-t-d, just slightly worse than the decline in Asia as a whole. Moreover, valuations in Korea look fairly cheap, with 12-month forward PE on 9.5x and price/book on 1.3x. However, Korea has been significantly cheaper than this in the past (PB got down to 0.8x in the last bear market). Also, analysts’ forecasts for 4% EPS growth this year and – especially – 15% growth next year look too optimistic. The success of President Lee Myung-bak’s reform programme will be a swing factor. After a bad start – most notably allowing imports of US beef, which provoked daily mass demonstrations – the

In an environment of credit risk and slowing growth, we recommend sticking to large, well-run companies with clean balance sheets in defensive or structural growth sectors. We are overweight industrials (which will benefit from infrastructure spending in China and elsewhere) and healthcare. Our biggest concerns are in financials (likely to be hurt by rising corporate defaults), IT (where earnings forecasts are still too high), consumer discretionary (which are likely to be affected by a slowdown in consumer spending) and telecoms (excess competition).

6. Inflection points

Will export growth start to slow Can President Lee Myung-Bak start to implement reforms Further declines in house prices in Seoul How much danger of failures among small banks Will retail investors continue to put money in investment trusts Source: HSBC

7. Sector weightings and Stock screening Sector

Sector weightings

Stocks rated Overweight

Consumer discretionary Consumer staples Financials Healthcare Industrials Technology Materials Telecoms Utilities

Underweight Neutral Underweight Overweight Overweight Underweight Neutral Underweight Neutral

Lotte Shopping Co Ltd LG Household & Health Car, KT&G Dongbu Insurance Co Ltd, Pusan Bank, Shinhan FGL Hyundai Marine & Fire Ins Yuhan Corp Samsung Techwin Hyundai Heavy Industries POSCO KT Freetel

Stocks rated Underweight

LG Chemical Limited

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Further falls  MSCI Korea has fallen 40% y-t-d in dollar terms

120

 Worst performing sector y-t-d is energy (-43%)

100

 Best performing sectors are consumer discretionary (-5%) and consumer staples (-9%)

80 60 40 Sep-07

Nov -07 Jan-08 Cy clicals Financials Main index

Mar-08 May -08 Defensiv e IT

Jul-08 Sep-08 Energy Telecoms

Source: HSBC

10. Economy

11. HSBC forecasts below consensus Consensus forecast on Real GDP growth

5.5%

 The consensus real GDP growth forecast for 2008 has been cut to 4.4%, from 4.9% at the start of the year  The consensus forecast for next year is 4.3%

5.0%

 HSBC forecasts 3.9% growth this year and 3.4% growth next

4.5%

2006

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

Sep-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

4.0%

2009

Source: Consensus Economics, HSBC

12. Leading indicators

13. Economic indicators deteriorating

40

600

20

500

0

400

-20

300

-40

200

-60

100 2002

2003 2004 2005 2006 KR Econ Performance Index

 Korean economic data has deteriorated sharply in the past few months  The HSBC Economic Performance Index shows that net 11% of indicators have declined over the past three months  In particular, the Business Confidence Index has fallen to 79 from 92 in May, and consumer confidence to 91 from 104 at the start of the year

2007 2008 MSCI KR (RHS)

Source: Bloomberg, MSCI, HSBC

% y-o-y

14. Earnings

15. Strong rebound forecast for next year… Korea

120 100 80 60 40 20 0 -20 -40 -60

 This year, the strongest growth is expected from consumer discretionary (+37%)  In 2009, strongest growth is forecast for utilities (which are expected to make zero in 2008) and telecoms (37%%)

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: I/B/E/S, HSBC

40

 Consensus expects Korean EPS to grow by 4 % in 2008 and 15% in 2009

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. …but downward revisions continue  Over the past three months, the Korean 2008 EPS forecast has been revised down by 8.9% and the 2009 forecast by 9.4%

100 80 60 40 20 0 -20 -40 -60 -80

 For the current year, the biggest revisions in the past three months have been in IT (-35%) and materials (+17%)

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

 For next year, the biggest revisions have been utilities (-82%) and materials (+13%)

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

18. Valuation

19. Cheap – but it has been cheaper in the past  12-month forward PE has fallen to 9.5x

60x 45x

 That is well below the long-run average of 11.2x, but still well above the low of 5.3x that Korea reached in the 2001-3 bear market

30x

 Price/book has fallen to 1.3x, lowest in Asia ex Japan after Hong Kong. In the last bear market it got to 0.8x

15x

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

0x

12-month fw d PE Source: HSBC

20. Sector valuation

21. Mostly in line with history 12-month fw d PE

60x 50x 40x 30x 20x 10x 0x

5-y ear PE mean

 Aside from utilities, where earnings are temporarily depressed, the most expensive sectors relative to the past five years are telcos (11.5x v. 9.3x) and consumer staples (16.2x v. 13.6x)

s

gy En er

ria l ate M

nc ial s

Fi na

st r ial s

In

du

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IT

ns .d Co

lco Te

tap ns .s

Co

Ut ilit i

es

 Cheapest sectors relative to history are energy (6.3x v. 8.4x) and industrials (7.9x v. 10.3x)

Source: I/B/E/S, HSBC

22. Foreign flows 40

 The selling has accelerated in recent months, with net sales of USD10bn in July-September alone

20 USDbn

23. The selling goes on  Over the past two years, foreign investors have sold USD59bn net of Korean stocks

0

 Domestic equity investment trusts were supporting the market, but their net inflows have slowed to a trickle, with September likely to see net outflows for the first time since April 2007

-20 -40 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 Jun-08 Sep-08

-60

Source: Bloomberg, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

China (overweight)  Pro-growth and pro-market policymaking could provide downside

protection, though market valuation isn’t rock bottom yet  MSCI China 2008 target revised down to 48 and 2009 target to 60  Regulatory risk, earnings visibility and share buybacks are key

considerations for sector allocation

Investors’ dilemma In spite of resilient economic growth, Chinese equity markets have been in free-fall this year, crippled by the once-in-a-century US financial crisis. The valuation of MSCI China dropped below 9x on 12-month consensus forward PE basis during intraday trading on 17 September, down 65% from its peak level last October and close to previous market bottoms in 1997 and 2003. But sentiment appears to have bottomed out after the announcement of the US government’s USD700bn bailout plan and the Chinese

government’s decision to cut stock trading stamp duty and increase its holdings in A-share listed state-owned enterprises. Notably, the PBoC also made a pre-emptive move to cut the benchmark lending rate, and the reserve requirement ratio for smaller banks, in order to cushion against downside growth risk. Investors are left in a dilemma: in the short term, risk aversion will probably continue and analysts’ earnings forecasts are subject to further downward revisions; but valuation has become quite attractive from both a historical and regional

Key financial and economic forecasts 1. Returns (%, USD)

3-month 6-month 12-month 24-month

2. Economic forecast MSCI China

HSCEI

-25.7 -30.8 -48.0 -8.3

-23.8 -27.0 -46.7 2.7

4. Q3 2008 sector performance (%)

Financials Technology Defensives Telecom Energy Cyclicals

GDP growth (%) Consumer prices (%) CNY/ USD Short interest rate (%)

3. Valuation 2008

2009

9.7 6.7 6.9 3.3

9.1 4.2 6.5 2.7

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

10.6 1.9 3.3 8.7 12.0

9.1 1.7 3.8

2008

2009

13.3 18.0 2.8 -42.9

16.6 18.3 3.0 -48.1

5. Earnings (%)

Absolute

Relative

-18.2 -18.6 -22.9 -25.3 -29.3 -35.0

3.6 3.2 -1.2 -3.5 -7.6 -13.2

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

comparison perspective, and the long-term growth profile of China remains intact. We revise down our end-2008 index target for MSCI China to 48 from 70, or largely flat to year-end. We derive this by adding 150bps to our usual cost of equity of 11.5% to take into account higher risk perception, and assume only 10% EPS growth in 2009 (versus consensus of 18%). Our end-2009 target is revised to 60, giving 25% upside in 2009, on the grounds that risk premiums should normalise. Investors need to closely monitor: i) the scope and scale of a possible fiscal stimulus package for 2009; ii) the overall credit quota and credit policy in the property sector; iii) financial innovations such as margin trading, short-selling and onshore index futures in the A-share market; and iv) share buybacks or increased shareholdings by controlling shareholders such as Central Huijin, PetroChina, China Unicom, China Coal and Tsingtao Beer group companies.

Sectors and stocks In addition to valuation – where we now focus more on PB than on PE – the three key considerations for our sector allocations and stock picks are regulatory risk, earnings visibility and share buybacks. First, the Chinese government is very hands-on, micro-managing profits of stateowned enterprises. For instance: i) asymmetrical rate cuts/hikes to shift profits between banks and non-financial sectors; ii) asymmetrical telecom

regulations to balance growth of strong and weak players; iii) temporary price caps for coal to help IPPs; and iv) highly-regulated oil and electricity prices to subsidise manufacturers, though these subsidies could be removed gradually going forward. Second, consumer staple, telecom and banking sectors appear most vulnerable to earnings revision post 3Q08 results. Last, we in general prefer big-cap SOEs due to their stronger financial position, better trading liquidity and higher possibility for share buybacks or increase of shareholding by controlling shareholders. For the three index heavyweights, we downgrade financials to neutral, and retain overweight energy and neutral telecoms. We see more risk of a slowdown in consumption than in fixed-asset investment, so we end the overweight on consumer staples and downgrade to underweight. We upgrade both industrials and materials to overweight from underweight, due to attractive valuations, gradually easing raw materials costs and probable financial stimulus package that will spur infrastructure spending. 6. Inflection points Party plenary session in early October – land reform bill 3Q08 macroeconomic statistics to be announced in mid-October National Economic Conference in Dec. – fiscal/monetary policies Financial innovation in A-share market in 4Q08 Source: HSBC

7. Sector weightings and Stock screening Sector

Sector weightings Stocks rated Overweight

Stocks rated Underweight

Consumer discretionary Consumer staples Energy Financials Healthcare Industrials

Underweight Underweight Overweight Neutral

PICC Property & Casualty

Technology Materials Telecoms Utilities

Underweight Overweight Neutral Neutral

Overweight

Li Ning Co Ltd., China Yurun Food Sinopec, CNOOC Ltd., PetroChina CIIH, China Citic Bank, Industrial Com Bank Of Ch

China COSCO Holdings Co, Shanghai Electric Group, China Eastern Airlines-A, China Southern Dongfang Electric Corp Airlines-A, China State Shipbuilding Lenovo Group Ltd Maanshan Iron & Steel, Yanzhou Coal Mining Co Lt China Mobile LTD Xinao Gas, Datang Power, China Resources Power

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Testing the baseline  MSCI China slumped to a 22-month low, or 47% down from the peak of last October, but the latest government actions are likely to set a baseline to the market

130 110 90

 Technology, financials and defensives led the market; telecom and energy were in line; cyclicals lagged

70

 Helped by the government’s intention to purchase shares of the three largest banks, financials ended up down only 14% last quarter, compared to a 19% fall for the main index

50 30 Sep-07

Nov -07

Jan-08

Cy clicals Financials Main index

Mar-08

May -08

Jul-08

Defensiv e IT

Sep-08

Energy Telecoms

Source: HSBC

10. Economy

11. 2008 GDP revised down

Consensus forecast on Real GDP growth

12% 11%

 China’s economy grew 10.4% in the first half of this year, a sharp slowdown from 11.95% in the first half of last year  The current consensus for 2008 GDP growth is 9.9%, which has been revised down slightly from 10.1% forecast in June

10%

 HSBC forecasts GDP growth at 9.7% for 2008

9% 8%

2006

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

7%

2009

Source: Consensus Economics, HSBC

12. Leading indicators

13. Pre-emptive move

140 120

110 90

100 80 60 40

70 50

 Economic performance has stayed roughly steady amid the continued decline in the stock market  Government started easing monetary policy as a pre-emptive move to limit further downside risk of the economy  Other growth figures, such as exports, retail sales and fixed asset investment, stay above 10%

30

20 0

10 2002

2003 2004 2005 2006 CH Econ Performance Index

2007 2008 MSCI CH (RHS)

Source: Bloomberg, MSCI, HSBC

% y-o-y

14. Earnings China

100 80 60 40 20 0 -20 -40 -60 -80

 Over the past quarter, the forecast for 2008 has been revised down from 16.5% and that for 2009 from 18.0% due to a tougher business environment and worries about the impact of the US financial crisis  Sector-wise, consumer staples and IT are forecast to have the highest growth rates, and industrials and utilities the lowest

1995 Source: I/B/E/S, HSBC

44

15. Worries about profitability  Currently, analysts forecast 13.3% and 16.6% EPS growth for 2008 and 2009, respectively

1997

1999

2001

2003

2005

2007

2009

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. Earnings momentum abated  Earnings momentum has been sluggish since the peak last November, and there is no sign of a swift recovery

40 20 0 -20 -40 -60 -80

 Consumer staples, financials and telecoms exhibit the strongest earnings momentum, with utilities and consumer discretionary the weakest

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

 This kind of low level of momentum was seen at the end of 2006. In an environment of more expansionary policies, forward earnings may slowly improve in coming quarters

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

18. Valuation

19. Market derated further  PE plummeted to 10.5x in September, a month-end level the market last saw in late 2005

40x 35x 30x 25x 20x 15x 10x 5x

 The number briefly touched 9.0x on September 17 but quickly rebounded, shored up by US bail-out news and Chinese market-support measures

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

 The current valuation is lower than most markets in the region, except Indonesia, Thailand and Korea

12-month fw d PE Source: HSBC

20. Sector valuation

21. Financials under pressure 12-month fw d PE

30x 25x 20x 15x 10x 5x 0x

5-y ear PE mean

 Financials, industrials, materials and consumer staples have been sharply derailed from their five-year averages. Consumer staples suffered from recent food safety news, and financials have seen continued selling pressure  IT trades about 48% above its five-year average

s ate ria l M

gy En er

str ial s

In du

nc ial s

Fi na

lco Te

Ut ilit ies Co ns .s tap Co ns .d is c r

IT

 Other sectors, such as energy and telecoms, are rated around their averages, reflecting a mean reversion pattern

Source: I/B/E/S, HSBC

USDbn

22. Foreign flows

23. Ebbs and flows

20

 Since the beginning of this year, global mutual funds have sold Chinese equities at net value of USD4.9bn

15

 A net buy of USD0.36bn occurred in July, yet not significant enough to reverse the downward course

10

 Foreign flows accounted for over 40% of the Hong Kong market’s turnover in 2007

5

Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08

Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07

Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05

0

Source: EPFR, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Taiwan (underweight)  Taiwan was the worst performing market in Asia in Q2  Risks remain high: we expect foreigners to continue to sell,

confidence to weaken further, and earnings to be revised down  We forecast TAIEX to end 2008 at 5500 and recommend

defensive sectors such as materials, energy and telecoms

Further to fall TAIEX fell 23% in Q3. It is easy to blame this on the financial turmoil in the US, but Taiwan underperformed the S&P500 by as much as 14%. What made investors particularly nervous was that the Taiwanese government pulled everything out of its tool box to prop up the market, but in vain. The government introduced a stream of measures in an attempt to stabilise the market. These included a ban on shorting stocks, relaxing the capital adequacy ratio for financial holding companies so more could buy back shares, and

ordering the National Stabilization Fund, which has funds of TWD500bn, to buy stocks. The market rebounded somewhat on news of a bail-out for US financial institutions. But we do not think this is sustainable and expect the market to fall further. Why?  Foreign selling is likely to continue. The market value of foreign holdings of Taiwanese stocks totals USD152bn. Given the average daily pace of net sales by foreigners in Q3, USD105m, it takes two

Key financial and economic forecasts 1. Returns (%, USD)

3-month 6-month 12-month 24-month

2. Economic forecast MSCI Taiwan

TSE

-28.1 -36.2 -37.6 -19.6

-24.0 -33.7 -39.2 -16.9

4. Q3 2008 sector performance (%)

Telecom Energy Defensives Technology Cyclicals Financials

GDP growth (%) Consumer prices (%) TWD/ USD Short interest rate (%)

3. Valuation 2008

2009

3.9 4.2 31.1 2.3

3.3 3.7 32.2 2.2

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

12.1 1.4 6.0 -3.7 9.4

10.8 1.3 6.1

2008

2009

-20.2 11.2 1.7 -6.8

12.1 11.9 2.8 -8.2

5. Earnings (%)

Absolute

Rel to MXAP

-12.5 -13.3 -19.9 -24.2 -35.5 -37.4

9.2 8.5 1.9 -2.4 -13.7 -15.6

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

years to liquidate that position. Foreign selling abated a little in September, but this was misleading: during the most bearish phase, foreigners who wanted to sell were unable to do so because many stocks fell by their 7% daily price fluctuation limits. We believe foreign selling will intensify if stock prices recover.  Confidence is deteriorating. President Ma’s approval rating has dropped to 25% and his disapproval rating has risen to 48%, according to a survey by Taiwan News in September. As a point of reference, when President Chen was about to leave office in May after a series of scandals, his approval rating was 18%, not a lot lower than Ma’s current rating. Domestic investors have lost confidence in the stock market, too. As an indicator of this, outstanding margin long positions as a percentage of daily turnover have dropped from 81% in July 2007 to only 29% this August.

forecasts are likely to have significant downward revisions in October when preannouncements start for Q3 results and companies give more guidance on the 2009 outlook.

Sectors and stocks In such a risky environment, we recommend investors stay defensive and pick sectors that have high dividend yields, attractive valuations, low exposure to exports and sound balance sheets, in particular materials, energy and telecoms. The rapid slowing of exports and delays in implementing infrastructure projects have dampened the outlook for employment and consequently for domestic consumption. As a result, we downgrade retail from overweight to underweight. We remain underweight on financials, industrials and technology due to the unfavourable global environment.

 Further downward earnings revisions are likely. The consensus earnings growth forecast for 2008 was revised down by 9% in

6. Inflection points

August and a further 7% in September, bringing it to -20%. All sectors except

Earnings season starting in late October

telecoms were revised down. But 2009 earnings growth is still forecast to be 12%,

Source: HSBC

Trend of export growth

Second round of negotiations with Beijing in November

unrealistically high in our view. Next year’s

7. Sector weightings and Stock screening Sector

Sector weightings

Stocks rated Overweight

Consumer discretionary Consumer staples Energy Financials Healthcare Industrials Technology Materials Telecoms Utilities

Underweight Underweight Overweight Underweight

Fubon FHC

Underweight Underweight Overweight Overweight

Wistron Corporation, Asustek, Acer Nanya Plastics, China Steel Corp

Stocks rated Underweight

High Tech Computer

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Following the US  MSCI Taiwan dropped 26% in Q3

150

 Materials and financials both dropped 34%, technology dropped 21%

130

 Telecoms held up best, dropping only 9% in Q3

110 90 70 50 Sep-07

Nov -07

Jan-08

Mar-08

Cy clicals IT Main Index

May -08

Jul-08

Defensiv e Telecoms

Sep-08

Financials Energy

Source: HSBC

10. Economy

11. Further GDP downgrades likely Consensus forecast on Real GDP growth

5.5%

 Consensus GDP growth is forecast to be 4.3% in 2008 and 4.4% in 2009

5.0%

 HSBC economics team forecasts GDP growth of 3.9% and 3.5% for 2008 and 2009 respectively

4.5%

 Our revised forecasts are a significant downgrade from the original forecasts of 4.9% in 2008 and 5.2% in 2009

4.0%

2006

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

Sep-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

3.5%

2009

Source: Consensus Economics, HSBC

12. Leading indicators

13. Economy turning sour

100

400

80

350 300

60

250 40

200

20

150

0

100

2002

2003 2004 2005 2006 TW Econ Performance Index

 Our Economic Performance Index has dropped precipitately  Although inflation is contained at 4.8%, exports are growing at the slowest pace in five years, only 5.4% y-o-y in August  We expect consensus GDP growth forecasts to be revised down further given the sluggish domestic demand and deteriorating export growth expected in coming months

2007 2008 MSCI TW (RHS)

Source: Bloomberg, MSCI, HSBC

% y-o-y

14. Earnings

15. Earnings growth slowdown Taiw an

60 50 40 30 20 10 0 -10 -20 -30 -40

 However, we expect the upcoming earnings season to be even gloomier and think analysts will revise down their forecasts further  Analysts still expect 12% earnings growth in 2009, which is unachievable in our view

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: I/B/E/S, HSBC

48

 Earnings are expected to contract by 20% in 2008

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. Weakest earnings momentum in Asia ex Japan

50

 Taiwan’s earnings momentum has been in negative territory for the past eight months

30

 It is the weakest among all Asia ex Japan markets

10

 Momentum for all sectors has turned negative, with industrials the weakest sector

-10 -30 Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

Sep-94

Sep-93

Sep-92

-50

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

18. Valuation

19. PE in the middle among Asia ex Japan peers  MSCI Taiwan 12-month forward PE is 11x, cheap compared to history but right in the middle among other markets in Asia ex Japan

65x 55x 45x 35x 25x 15x 5x

 Consumer staples is the most expensive sector, at 16x 12-month forward PE. Materials is the cheapest sector, at 8x 12-month forward PE

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

 Since Taiwan is the most cyclical market in Asia, the mediocre valuation does not present a buying opportunity yet in our view

12-month fw d PE Source: HSBC

20. Sector valuation

21. Reverting to five-year mean 12-month fw d PE

20x

5-y ear PE mean

 Most sectors are trading roughly at their five-year mean

15x

 Financials and tech are slightly below mean, but we expect further declines in these sectors given the unstable global environment

10x

 Materials has the lowest valuation (8x) and the highest dividend yield (10%). It is our favourite defensive pick

5x

ria ls ate M

IT Co ns .d is c r

lco Te

Fi na nc ial s

du In

Co ns .s

tap

st r ial s

0x

Source: I/B/E/S, HSBC

23. Foreign fund outflows to continue  Foreign investors sold TWD202bn worth of equities during 3Q08

70 60 50 40 30 20 10 0

 But they have so far sold only 22% of the funds they put into Taiwan in 2003-7

Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08

 Total market value of foreign holdings is TWD5tn, or USD152bn, so there is still plenty of room for foreigners to sell more

Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07

USDbn

22. Foreign flows

Source: Bloomberg, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Hong Kong (neutral)  MSCI Hong Kong is a mixed bag: property prices are likely to fall

10%, and liquidity to dry up a little as expectations of RMB appreciation recede  But Fed rate cuts, continued strong China growth and Hong

Kong’s defensive nature limit the downside risk  We cut our Hang Seng Index targets to 18,000 for 2008 and

22,000 for 2009, but remain neutral

Stay defensive

at 3.2%, is expected to edge up in coming months.

Hong Kong’s macroeconomic situation has been a mixed bag this year: i) economic activity has started to slow, with real GDP growth declining to 4.2% in 2Q and a forecast 5.1% in 3Q, down from 7.3% in 1Q; ii) headline CPI eased to 4.6% y-o-y in August from 6.3% in July, but all due to government subsidies; and iii) the job market remained robust in August despite global economic fluctuations, but the unemployment rate,

Investors’ two major concerns on MSCI Hong Kong are: i) how severe is the risk of asset price deflation, given the widely expected strength of the USD and the fact that the property sector represents close to 40% of index weight; and ii) could further liquidity be withdrawn from Hong Kong, given the concerns about China’s economy slowing and the fact that speculation on RMB appreciation has cooled substantially?

Key financial and economic forecasts 1. Returns (%, USD)

3-month 6-month 12-month 24-month

2. Economic forecast

MSCI Hong Kong

HSI

-23.5 -28.2 -37.5 -8.3

-18.5 -22.6 -33.6 2.7

4. Q3 2008 sector performance (%)

Defensives Financials Telecom Cyclicals Technology

GDP growth (%) Consumer prices (%) HKD/ USD Short interest rate (%)

3. Valuation 2008

2009

4.5 4.8 7.8 2.2

3.9 5.0 7.8 1.9

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

12.6 1.2 3.5 6.4 8.1

11.7 1.1 3.8

2008

2009

-26.1 9.3 2.5 12.1

8.3 9.5 3.3 10.4

5. Earnings (%)

Absolute

Rel to MXAP

-2.7 -24.1 -25.8 -27.5 -35.8

19.0 -2.4 -4.0 -5.7 -14.0

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

Our property analysts forecast a 10-15% correction in property prices in Hong Kong, but they don’t believe a property market meltdown is likely. The favourable supply and demand situation should help limit downside risk. Moreover, our US economists expect the Fed funds rate to be cut by 100bps in 2009. This implies banks in Hong Kong are unlikely to raise rates and our Hong Kong economists now expect Hong Kong lending and saving rates to stay unchanged in 2009, at 5.25% and 0.01% respectively, which should also help property transaction volume. China’s GDP growth is likely to stay above 9.5% in the coming years, cushioned by the PBoC’s preemptive easing, plus likely fiscal stimulus policies such as tax rebates on exports and equipment investment. Hence, our China economists continue to expect moderate RMB appreciation against the USD of about 5% annually. Raising our cost of equity assumption by150bps to 12% due to higher equity risk and assuming 5% EPS growth in 2009 (versus the consensus 12%), we revise our end-2008 Hang Seng index target down to 18,000 from 24,000, or largely flat by year-end. We revise our end-2009 target to 22,000 from 25,000, giving 20% upside in 2009, on the grounds that the risk premium is likely to normalise and growth concerns on China abate.

Sectors and stocks We are defensive in sector allocation: overweight telecoms, REITs and industrials; neutral on utilities and banks; and underweight property developers, IT and consumer discretionary. Utilities and telecoms have been relative outperformers since the market peaked last October, and we continue to expect that these blue-chip companies will prove to be a shelter for investors in the bear market, given the high dividend yield protection and experienced managements that have gone through many difficult cycles in the past decades. Between the two, we prefer telecoms over utilities due to lower valuations and better growth profiles. HK-listed REITs continue to offer the best value in the market (yielding 5-10%) except that trading liquidity is thin. We prefer property investors to developers. In addition to positive earnings revision momentum, we also overweight industrials for similar consideration of low valuation, high dividend yield and good corporate management. Liquidity, loan growth and credit quality concerns on banks appear overplayed and we prefer big local banks that are traded at attractive valuations.

7. Sector weightings and Stock screening Sector

Sector weightings

Consumer discretionary Consumer staples Energy Financials

Underweight n.a. Underweight Neutral

Healthcare Industrials Technology Materials Telecoms Utilities

n.a. Overweight Underweight Underweight Overweight Neutral

Stocks rated Overweight

Stocks rated Underweight

Sino Land Company Ltd, Champion REIT, Hang Lung Properties, Bank of China (HK), Swire Pacific Pacific Basin Shipping, HAECO, Cathay Pacific

PCCW Hong Kong & China Gas

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Vulnerable to the turmoil  The market further tumbled amid the aggravated US financial turmoil. MSCI Hong Kong index shed 19% in the past quarter, and 34% year to date

130 110

 Defensives kept outperforming the market, with only a 5% drop in the past quarter, while technology and cyclicals underperformed

90

 Financials and telecoms ran in line with the market, sliding 17% and 19% respectively during the past quarter

70 50 Sep-07

Nov -07

Jan-08

Mar-08

Cy clicals IT

May -08

Jul-08

Defensiv e Telecoms

Sep-08

Financials Main index

Source: HSBC

10. Economy

11. 2008 GDP revised down

Consensus forecast on Real GDP growth

7%

 Hong Kong's GDP growth slowed to 4.2% y-o-y in 2Q from 7.3% in 1Q, or 5.8% for the first half of this year  Consensus revised down 2008 growth to 4.4% from the 4.9% forecast last quarter

6%

 HSBC forecasts 4.5% GDP growth for the full year 2008

5%

2006

2007

2008

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

Jan-06

Sep-05

May-05

Jan-05

4%

2009

Source: Consensus Economics, HSBC

12. Leading indicators

13. Macroeconomic situation a mixed bag

60

16100

40

14100 12100

20

10100 0

8100

-20

6100

-40

4100 2002

2003 2004 2005 2006 HK Econ Performance Index

 The stock index took a hit amid a harsh environment overseas and gloomy China markets  CPI headline inflation eased to 4.6% y-o-y in August from 6.3% in July, but mainly due to government subsidies  Job market remains robust despite global economic fluctuations. But the unemployment rate is expected to edge up in coming months

2007 2008 MSCI HK (RHS)

Source: Bloomberg, MSCI, HSBC

14. Earnings

15. Growing profit remains challenging Hong Kong

70

% y-o-y

50 30

 Excluding extraordinary items, aggregate earnings would still slide by about 5% in 2008

10

 We expect more earnings downgrades to come as the property market corrects: 2009 earnings growth could end up largely flat

-10 -30 -50 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: I/B/E/S, HSBC

52

 Earnings growth in 2008 and 2009 are forecast to be -26.1% and 8.3%, with the 2008 number distorted by Hutchison’s telecom deal last year

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. Earnings momentum deteriorated  Forward earnings momentum, which picked up in Q2, fell back to single digits in Q3

30 20

 Sector-wise, IT and industrials exhibited the strongest momentum, with 12month forward EPS revised up 37% and 23% from six months ago

10 0

 Utilities and materials were the most sluggish sectors, whereas financials and telecoms moved in line with the overall market

-10 -20 Sep-08

Sep-07

Sep-05 Sep-06

Sep-03 Sep-04

Sep-01 Sep-02

Sep-00

Sep-98 Sep-99

Sep-97

Sep-96

Sep-94 Sep-95

Sep-92 Sep-93

Sep-90 Sep-91

-30

Hong Kong 6-m onth earning m om entum Note: Earnings momentum = 6-month % change in 12- month forward consensus forecast. Source: HSBC

18. Valuation

19. PE close to SARS bottom

25x

 PE dived further to 13x, well below its five year average of 16.5x, and representing a 40% de-rating since the start of the year

20x

 The current level is very close to the bottom in 2003, when the city was struck by the SARS epidemic

15x

 Nevertheless, it is still expensive compared to other countries in the region, being lower only than Japan and India

10x

Sep-06 Sep-07 Sep-08

Sep-03 Sep-04 Sep-05

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02

5x

12-month fw d PE Source: HSBC

20. Sector valuation

21. Rewards for the defensive 12-month fw d PE

30x

5-y ear PE mean

 Industrials, consumer discretionary and IT are obviously derated from their five-year means due to the concern about cyclicals’ profitability

25x 20x

 Utilities is rewarded with a valuation premium for its defensive characteristics in the bear market

15x

 Telecoms is a little above and financials slightly below their five-year means

10x 5x IT

Industrials

discr

Cons.

Financials

Utilities

Telco

0x

Source: I/B/E/S, HSBC

22. Foreign flows 7 6 USDbn

5 4 3

23. Flee or return  Global mutual funds have pulled a total of USD4.4bn from this market since the beginning of 2008  In July there was small net buying worth USD0.25bn, but this may not be substantial enough to reverse the selling momentum  Funds are likely to return only when the global investment environment approaches stability

2 1 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08

0

Source: EPFR, HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

India (neutral)  Concerns remain: global risk aversion, slowing earnings, politics  But high cash levels and lower valuations should cap downside  We raise to neutral; Sensex to recover to 15,000 by end-09

The bad news and the good The Indian economy continues to face headwinds, which means the stock market will struggle.  Global risk aversion remains high. Foreign investors sold USD2bn of Indian shares in September and USD9bn y-t-d.  There has been a significant slowdown in corporate earnings over the past two quarters: for the quarter ending June 2008, net income of NSE-listed companies grew 8.8% y-o-y. Corporate margins are under pressure: EBTDA margins, at 17%, are at the lowest in three years. Looking ahead, the effects of RBI monetary tightening will hurt top-line growth,

although the decline in commodity prices may help stabilise margins. This means that, in our view, corporate earnings are likely to be under pressure for four to six quarters. A pick-up in earnings growth is likely only towards end of CY2009.  Political uncertainties. A general election is due in May 2009. This is likely to keep markets nervous and cap a rally. The shape of the government that emerges after the elections can be a trigger for markets. Set against this, however, are a number of positive factors which we think will limit the downside risk for India, at least relative to other markets in

Key financial and economic forecasts 1. Returns (%, USD)

3-month 6-month 12-month 24-month

2. Economic forecast MSCI India

SENSEX

-14.4 -35.2 -38.5 -0.8

-4.5 -21.5 -25.6 3.3

4. 3Q08 sector performance (%)

Defensives Financials Energy Cyclicals Telecom Technology

GDP growth (%) Consumer prices (%) INR/ USD Short interest rate (%)

3. Valuation 2008

2009

7.5 8.1 43.3 8.9

7.3 7.5 43.8 9.3

PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

2008

2009

13.6 2.4 1.7 19.5 11.4

11.0 2.0 1.9

2008

2009

19.3 17.9 5.7 23.6

23.2 18.5 5.9 12.8

5. Earnings (%)

Absolute

Relative

-5.9 -7.0 -11.4 -16.6 -27.6 -28.7

15.9 14.8 10.4 5.1 -5.9 -7.0

Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

Notes: Performance figures for 3Q08 are updated to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.5-8% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

the region, and could lead to a sharp rebound next year once global risk aversion declines.

sales have held up in 2008, with August being the first month with a (small) negative flow. Fund managers have been cautious in investing in the market; as a result, cash levels are high, at 14% of assets.

 The capex pipeline remains strong at USD250bn for listed companies, which will help support earnings growth.  Monetary policy is likely to be eased in 2009: our economics team is looking for a cut of 100bps in the during the year starting in the first quarter, which is a trigger for markets.  Historically, Indian companies have the lowest volatility of earnings growth at 12% vs. 43% for the emerging market universe, indicating (relatively) lower earnings risk. There is good reason to believe that earnings in India will be more resilient than for global peers due to the more diversified nature of the market, lower exposure to commodities and low debt levels. We look for 5-10% EPS growth this fiscal year and 10-15% EPS growth next, lower than the 11% and 23% currently forecast by the consensus, but nonetheless decent.  Prospective PE, at 13x, is not ultra-cheap, but in terms of PEG, India is at a 6% discount to emerging markets, while historically it has traded at a premium of 25%.

Sectors and stocks We maintain underweight on the consumer discretionary sector. We are underweight on materials, as slowing global growth will impact top-line growth, and neutral on energy, since Indian oil marketing companies gain as crude oil prices fall. Consumer staples and healthcare have defensive characteristics, but valuations are high compared to growth prospects, so we are neutral. We maintain underweight on utilities, and have downgraded IT to neutral reflecting concerns about the fate of outsourcing business from troubled US financial firms. Financials remains our key underweight, as banks are likely to be hurt by rising NPLs and stress on margins. Industrials and telecoms remain our key overweights. 6. Inflection points RBI monetary policy meeting General elections Impact of trouble in US financial sector on outsourcing firms

 Domestic investors’ support for the market

Source: HSBC

remains a supportive factor. Mutual fund

7. Sector weightings and Stock screening Sector

Sector weightings

Stocks rated Overweight

Consumer discretionary Consumer staples Energy

Underweight Neutral Neutral

Financials

Underweight

Healthcare Industrials Technology Materials Telecoms Utilities

Neutral Overweight Neutral Underweight Overweight Underweight

Mahindra & Mahindra, Titan Industries Ltd Dabur India Welspun Gujarat Stahl Roh, Hindustan Petroleum, Reliance Industries Indiabulls Real Estate, Housing Development & Inf, Bank of Baroda Dr. Reddy's Lab. BHEL, Punj Lloyd Limited, Larsen & Toubro

Idea Cellular Ltd, Bharti Airtel Tata Power

Stocks rated Underweight

Tata Communications Reliance Infrastructure

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

8. Market performance

9. Market decline across the board…  All sectors down compared to one year ago

150 130

 Defensives, notably healthcare and consumer staples, have outperformed the wider market

110

 Cyclicals and telecoms have underperformed

90 70 50 Sep-07

Nov -07

Jan-08

Mar-08

Cy clicals Financials Main index

May -08

Jul-08

Defensiv e IT

Sep-08

Energy Telecoms

Source: HSBC

10. Economy 9%

11. …accompanied by fall in growth projections  Consensus GDP growth projections for 2008 are down from 8.2% last year to 7.5%

Consensus forecast on Real GDP growth

 Consensus GDP forecast for 2009 cut to 7.6% from 8% six months ago. HSBC forecast is 7.1% for CY2009e

8%

 Lower growth projections reflect the effect of a tighter monetary policy.] 7%

2006

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

6%

2009

Source: HSBC

12. Leading indicators

13. Leading indicators turning flat

25

1010

20

810

15

 Economic performance remains robust  Clear signs of slowdown; last quarter’s GDP growth was the lowest since 2005

610

10 410

5

210

0 -5

10 2002

2003 2004 2005 2006 IN Econ Performance Index

2007 2008 MSCI IN (RHS)

Source: HSBC

14. Earnings

15. Earnings growth projections optimistic India

35

 We expect consensus to revise down these forecasts in coming months

% y-o-y

25

 We expect earnings growth of about 10% over the next two years

15 5 -5 1994

Source: HSBC

56

 Consensus earnings growth estimates for CY2008 (19%) and CY2010 (23%) look too optimistic; earnings growth averaged 23% during the recent boom

1996

1998

2000

2002

2004

2006

2008

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Equity Strategy Asia Pacific Fourth Quarter 2008

16. Earnings momentum

17. Earnings momentum losing steam

30

 Consensus EPS for CY2008 revised down by 3.4% in the past six months; forecast EPS for CY2009 revised down by 4.1% over the same period

20

 We expect even slower momentum in the coming months

10 0 -10 Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

-20

India 6-month earning momentum Source: HSBC

18. Valuation

19. Valuations reasonable…  MSCI India at close to 13x is slightly lower than the historical average of 13.4x

25x

 Earnings forecasts may trend lower; de-rating a sign of concern over earnings growth

20x

 Valuations not cheap yet

15x 10x

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

Sep-94

5x

12-month fw d PE Source: HSBC

20. Sector valuation

21. …across the board 12-month fw d PE

25x

5-y ear PE mean

 With the exception of industrials, all sectors are close to their five-year mean  IT and consumer discretionary significantly below the five-year mean

20x

 De-rating of IT reflects concern over the US financial sector

15x 10x 5x

En e C o r gy ns .d is c r M ate ria ls

lco Te

ies Ut ilit

IT

He al t h ca re Fi na nc ial s

du In

Co ns .s

tap

st r ial s

0x

Source: HSBC

22. Foreign flows

23. Foreign selling to continue  Foreign investors have shed USD9bn y-t-d

60

 The only other time when foreigners were net sellers was in 1998

USDbn

50

 Foreign selling may continue for a while as global risk aversion remains high

40 30 20 10 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08

Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07

0

Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

ASEAN (overweight)  We like Singapore and Malaysia for their defensive characteristics  Indonesia shows structural progress but is too risky for this market  Thailand’s political problems won’t get solved soon – avoid

Stick to defensive markets

better this year than other markets in the region. It is down 31% y-t-d in USD terms, compared to the 39% decline in Asia ex Japan. We expect, in a difficult global environment, that Singapore will continue to outperform.

Singapore (stays overweight) As befits its status as a developed economy and defensive stock market, Singapore has held up

1. Key financial and economic forecasts Malaysia

Thailand

Singapore

Indonesia

Philippines

Return (%, USD) 3-month 6-month 12-month 24-month

-18.7 -27.4 -26.4 11.9

-23.7 -34.2 -28.2 -2.4

-23.1 -25.5 -33.5 5.2

-27.0 -32.1 -24.4 15.7

2.0 -22.6 -33.2 2.7

Q3 2008 relative sector performance (%) Energy Cyclicals Defensives Telecom Financials Technology

-15.4 5.6 4.6 11.5 12.5 n/a

-7.1 -11.6 15.1 5.1 4.7 n/a

n/a -2.6 -25.2 7.1 0.5 -3.7

-38.6 3.6 0.4 16.2 27.0 n/a

n/a 25.4 20.9 23.3 24.5 n/a

Economic forecast (2008) GDP growth (%) Consumer prices (%) Exchange rate Short interest rate (%)

6.0 5.9 3.33 3.6

4.1 6.5 33.7 3.70

3.8 6.5 1.40 5.4

6.1 10.0 9343.0 8.8

4.1 9.2 44.6 5.2

Valuations (2008) PE (x) P/B (x) Dividend yield (%) Implied growth (%) Implied COE (%)

11.5 1.6 4.8

8.3 1.5 5.4

11.4 1.5 4.5

10.4 2.8 4.5

13.7 1.9 4.4

9.8 10.2

2.8 11.4

5.4 9.1

23.8 15.9

23.7 10.5

Earnings (%) (2008) Earnings growth (y-o-y) ROE ROA Net debt/ equity ratio

-12.6 13.9 3.0 17.7

114.1 18.0 4.2 10.7

-3.4 13.1 3.0 7.0

16.3 26.8 6.3 0.0

0.8 14.2 3.4 4.9

Notes: Performance for Q3 2008 is up to 30 Sep 2008. Implied growth is derived from a 3-stage NPV analysis based on earnings stream: the first stage is 2 years of I/B/E/S earnings forecasts; the final stage is perpetual growth of 2.58% depending on the country; implied growth is calculated for years 3-10. COE is derived from a weighted average of USD bonds with the same credit rating as the country, local 10-year government bond yields and an equity risk premium. MXAP = MSCI Asia Pacific index Source: HSBC, I/B/E/S

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Equity Strategy Asia Pacific Fourth Quarter 2008

Valuations are now cheap: because of the drop in stock prices, PE has fallen to 10.8x, close to the low of 10.0x set in the Asia crisis. The economy is likely to slow further, producing real GDP growth this year of 4% on HSBC’s forecasts. But we also expect that Singapore will be one of the few countries in the region where growth next year should be better than this year: we forecast 5.5%. Moreover, the stock market is relatively immune to slowing exports, which come from foreign firms and small bio-technology companies, rather than listed stocks. Singapore has a range of welldiversified and well-managed blue-chip stocks which tend to hold their own even in difficult times. For this reason, we are overweight Singapore industrials, and include Singapore Airlines in our top picks. This is a market that could fall further, but it is likely to continue to be relatively resilient. It will also give a decent amount of upside in the event of a market rebound, say next year.

Malaysia (stays overweight) Malaysia has also proved fairly defensive over the past year, when it has been the third-best performing market in MSCI Asia ex Japan (after Singapore and Thailand). That is surprising in a way, given the political situation. Prime Minister Abdullah Badawi is under attack both from within his own party and from opposition leader Anwar Ibrahim. These struggles have got progressively nastier, with the government invoking the Internal Security Act to imprison opponents. It is impossible to forecast how the situation will pan out over coming months, but it is likely to come to a head soon. We are not too concerned about these developments. While they lead to short-term uncertainties, we believe that the development of a viable opposition is an important step forward

for Malaysia to become a more mature democracy. Meanwhile, the economy is likely to slow next year (we forecast 6.2% real GDP growth this year and 5.0% next) but not disastrously. Easy monetary policy has helped: Malaysia has been the one Asian market that has not raised rates this year, even though this does raise the risk of core inflation persisting longer than elsewhere. Valuations have become cheap, with 12-month forward PE falling to 11.2x – lower than in the 2000-3 bear market. And that is based on earnings forecasts which are quite cautious compared to the rest of the region: -13% for this year, and +5% for next. We expect that Malaysia will continue to perform defensively, given its high proportion of noncyclical stocks. However, unlike Singapore, it would be likely to lag in a rebound, and so investors should be quicker to switch out of this market in the event of stocks finding a bottom.

Indonesia (stays underweight) The Indonesian market has held up remarkably well this year: it is down only 36%, outperforming MSCI Asia ex Japan by about 6%. This is despite the fact that this is usually a volatile, high-beta market, with the lowest long-run valuations in the region. Part of the reason is that the Indonesian stock market does have a reasonably high exposure to commodities, which helped until recently. But economic growth has been decent too, with GDP growing consistently above 6% since 2006. This may have been propelled by the forthcoming presidential election, due in April next year, which has led to a certain degree of government spending. Structural improvements are contributing, too. The political situation is stable (unusual in south-east Asia this year), and Indonesia’s rampant corruption is starting slowly

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Equity Strategy Asia Pacific Fourth Quarter 2008

to improve: in Transparency International’s latest annual survey, Indonesia rose 17 places among the 180 countries surveyed – although it still comes a rather lowly 126th. However, while we are happy to keep some exposure to this market, we feel that global risk is too great to make it an overweight. There are still many problems facing the country. For one, next year’s presidential race is currently too close to call, with former president Megawati Sukarnoputri putting up a strong challenge to President Susilo Bambang Yudhoyono. Megawati was not an effective president before, and her election would unsettle the market. The economy is also unlikely to maintain its current momentum: we forecast growth to slow to 4.9% next year. Moreover, valuations remain relatively expensive compared to history. PE, at 8.6x, compares to a low of 5x in the 2000-3 bear market, and PB is still high at 2.9x, compared to previous lows of 1.3x. Indonesia has undoubtedly improved structurally over the past few years and therefore deserves a higher rating – but not that much higher.

Thailand (stays underweight) The Thai market remains mired in the evershifting political situation, with one Prime Minister forced out in September and ongoing demonstrations in Bangkok. We cannot see prudent portfolio investors putting their money back into this country until a lasting solution to the current impasse has been found. Foreigners have already sold a net USD4bn so far this year. The underlying political problem is deep-rooted. The Bangkok middle class likes the status quo and is suspicious of democracy; it is supported by the establishment. The rural populace has a majority and likes the populist reforms of former Prime Minister Thaksin and his proxies. Until this

underlying tension is sorted out, there can be no sustainable government. In the meantime, the economy continues to stagnate. We forecast real GDP growth at 4.1% this year and only 3.1% next. Valuations in the stock market are not high: forward PE is only just under 8x. But this is based on analysts’ forecasts of 28% growth in net profit this year, and 11% next, which seem unrealistically high. Moreover, Thailand has consistently traded at a single-digit PE in the past five years, so the current multiple is not notably low. Given the risks (for example, of another coup), we would be reluctant to buy this market at almost any price.

Philippines (stays underweight) The Philippines is simply not the sort of market investors want to be in in an environment like the current one. This market has high political risk (with coup attempts almost annually), it allowed inflation to run away earlier this year because of irresponsible monetary policy, and its economy is overly dependent on one driver – remittances – which seem likely to slow with the world entering a recession. Neither is it compellingly cheap, with forward PE at 12.4x, and that based on unrealistically optimistic earnings expectations of 14% EPS growth next year. One to avoid.

Vietnam (small off-benchmark position) Valuations have got pricey after the strong stock market rally in the summer. By end-August, the market reached a 12-month forward PE (assuming -10% growth this year, and +20% next) of 14.8x, and has now fallen back to 14.6x. This represents a significant premium compared to other longterm structural growth markets such as China and India. Foreigners have started to sell, for the first time since early 2007: in September, they sold

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Equity Strategy Asia Pacific Fourth Quarter 2008

USD166m net. In addition to global risk aversion, this suggests that country funds (which raised billions of dollars in 2007) are now finally fully invested. Foreigners, who continued to buy even as the Vietnamese market crashed earlier this year, can no longer be relied on to be steady buyers. The key, in our view, remains earnings. In H1 2008, large companies’ net profit fell 15%, mainly because of property and equity-related write-offs. The full-year numbers could possibly show an even bigger decline. Until the extent of further write-offs is known – and investors can judge the likely rebound in earnings next year – we see the market struggling. We therefore target the VN Index to remain roughly at its current level of 450 to the end of 2008, and then rebound to 550 (i.e. roughly in line with our expectation of 20% earnings growth) next year.

2. Inflection points Outcome of political situation in Thailand Who is next Prime Minister of Malaysia Events in run-up to next April’s Indonesian elections Is inflation dead in Indonesia, Philippines, Vietnam How much do exports decline in Singapore, Malaysia Source: HSBC

3. Sector weightings and Stock screening Sector weightings Consumer discretionary Consumer staples Energy Financials Healthcare Industrials Technology Materials Telecoms Utilities

Stocks rated Overweight

Stocks rated Underweight

UOB Singapore Airlines

Cosco Corp Singapore Ltd

Indosat

Notes: Stocks shown are those with market cap above USD1bn, where HSBC's analysts have an Overweight or Underweight rating, and where their target price is at least 15% away from the current stock price. Up to three stocks are shown in each category for each sector. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

4. Economy

5. Malaysia

Malaysia

6.5%

Consensus forecast on Real GDP growth

 The consensus real GDP growth forecast for 2008 has been cut to 5.5%, from 5.7% at the start of the year  The consensus forecast for next year is 6.2%

6.0%

 HSBC forecasts 6.2% growth this year and 5.0% growth next

5.5%

2006

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

2007

Sep-07

Mar-07

Dec-06

Jun-06

Sep-06

Mar-06

Jun-05

Sep-05

Dec-05

5.0%

2008

2009

Source: Consensus Economics, HSBC

6. Valuation

7. Malaysia Malaysia

25x 20x

 12-month forward PE has fallen to 11.2x  That is far below the long-run average of 16.3x, and even below the low of 11.7x that the country reached in the 2001-3 bear market  Price/book has fallen to1.6x. In the last bear market it got to 1.4x

15x 10x

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

Sep-94

Sep-93

5x

12-month fw d PE Source: HSBC

8. Economy

9. Singapore

8%

Singapore Consensus forecast on Real GDP growth

 The consensus real GDP growth forecast for 2008 has been cut to 4.2%, from 6.2% at the start of the year  The consensus forecast for next year is 4.6%

7%

 HSBC forecasts 4.0% growth this year and 5.5% growth next

6% 5%

2006

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

4%

2009

Source: Consensus Economics, HSBC

10. Valuation

11. Singapore Singapore

24x 22x 20x 18x 16x 14x 12x 10x

 That is below the long-run average of 16.6x, and even below the low of 11.9x that the country reached in the 2001-3 bear market

Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98

 Price/book has fallen to 1.5x. In the last bear market it got to 1.1x

12-month fwd PE Source: HSBC

62

 12-month forward PE has fallen to 10.8x

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Equity Strategy Asia Pacific Fourth Quarter 2008

12. Economy

13. Thailand

6.0%

Thailand Consensus forecast on Real GDP growth

 The consensus real GDP growth forecast for 2008 has stayed steady since the start of the year at 4.8%

5.5%

 The consensus forecast for next year is 4.6%

5.0%

 HSBC forecasts 4.1% growth this year and 3.1% growth next

4.5% 4.0%

2006

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Jun-06

Sep-06

Mar-06

Dec-05

Jun-05

Sep-05

3.5%

2009

Source: Consensus Economics, HSBC

14. Valuation

15. Thailand

25x

Thailand

20x

 12-month forward PE has fallen to 7.9x  That is below the low of 8.4x that country reached in the 2001-3 bear market  Price/book has fallen to 1.5x. In the last bear market it got to 1.3x

15x 10x

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

5x

12-month fw d PE Source: HSBC

16. Economy

17. Indonesia Indonesia

6.5%

Consensus forecast on Real GDP growth

 The consensus real GDP growth forecast for 2008 has been cut to 5.9%, from 6.2% at the start of the year  The consensus forecast for next year is 5.6%

6.0%

 HSBC forecasts 6.0% growth this year and 4.9% growth next

5.5%

2006

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

2007

Sep-07

Mar-07

Dec-06

Jun-06

Sep-06

Mar-06

Dec-05

Sep-05

Jun-05

5.0%

2008

2009

Source: Consensus Economics, HSBC

18. Valuation

19. Indonesia Indonesia

30x 25x 20x 15x 10x

 12-month forward PE has fallen to 8.6x  That is below the long-run average of 12.9x, but still well above the low of 3.5x that the country reached in the 2001-3 bear market  Price/book has fallen only to 2.9x. In the last bear market it got to as low as 1.3x

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

Sep-94

Sep-93

Sep-92

5x 0x

12-month fw d PE Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

20. Economy

21. The Philippines Philippines

7.0%

Consensus forecast on Real GDP growth

 The consensus real GDP growth forecast for 2008 has been cut to 4.7%, from 5.7% at the start of the year

6.5%

 The consensus forecast for next year is 4.8%

6.0%

 HSBC forecasts 4.1% growth this year and 3.9% growth next

5.5% 5.0%

2007

2008

Sep-08

Jun-08

Mar-08

Dec-07

Jun-07

Sep-07

Mar-07

Dec-06

Jun-06

2006

Sep-06

Mar-06

Dec-05

Sep-05

Jun-05

4.5%

2009

Source: Consensus Economics, HSBC

22. Valuation

23. The Philippines Philippines

25x

 12-month forward PE has fallen to 12.4x

20x

 That is below the long-run average of 14.9x, and close to the low of 11.7x that country reached in the 2001-3 bear market

15x

 Price/book has fallen to 1.9x. In the last bear market it got to 0.9x

10x 5x

Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08

0x

12-month fw d PE Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Sectors and stocks  Surprise, surprise – in bear markets, defensive sectors outperform  We have overweights in telecoms, healthcare, utilities  But we switch out of consumer staples into capital goods as

infrastructure spending should hold up better than consumption

Stick to the obvious

where leverage and financial risk are low.

Spending a lot of time thinking about sector allocation has not been a very valuable exercise recently. If you had judged correctly at the beginning of 2008 that we were in a bear market, you would, without thinking about it very hard, have overweighted utilities, healthcare and consumer staples, and avoided materials, financials, industrials and technology. As Table 2 shows, you would have been exactly right.

Valuations and, in particular, earnings forecasts do not give much guidance in this environment. As Table 4 shows, analysts are optimistic about the growth forecasts for every sector in 2009. They particularly expect a strong bounce-back in those sectors where growth has been cut sharply this year, most notably materials and technology. In an environment of slowing global growth, our preference would be for sectors such as telecoms and healthcare, where decent growth is fairly assured even if the cycle continues to turn down.

Since we expect that the bear market has at least another quarter or two to run, and that earnings growth is likely to disappoint next year, it makes sense to stick largely to the same sector allocation model. Our preference is for sectors where growth is structural rather than cyclical, where downward earnings surprises are relatively unlikely, and

1. Sector weightings Sectors Financials Industrials IT Consumer discretionary Materials Telecoms Energy Consumer staples Utilities Healthcare

HSBC recommended weight

Benchmark weight

Weightings

23.0% 18.0% 11.0% 9.0% 9.5% 7.0% 5.5% 5.0% 6.0% 6.0%

26.6% 14.6% 12.8% 11.4% 11.4% 5.6% 5.3% 5.1% 3.9% 3.3%

Under Over Under Under Under Over Neutral Neutral Over Over

Countries where sector is Overweight

Countries where sector is Underweight

AU, IN, JP, KR, TW TW HK, JP, KR, TW AU, CH, HK, IN, JP, KR, TW CH, TW AU, IN HK, IN, JP, MY, TW KR CH, TW CH, TW CH, MY IN JP, KR

CH, HK, IN, KR, SG

Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

2. MSCI Asia-Pacific sector performance (Q3) 3M Y-t-d

Utilities Health Care Consumer staples Telecom Financials Consumer durables Information Technology Industrials Energy Materials

-1.1 -4.8 -10.7 -13.3 -13.5 -15.0 -19.9 -20.4 -20.8 -24.8

MSCI Asia-Pacific

-16.4 -25.8

3M Y-t-d relative relative

-14.0 -9.8 -18.8 -27.6 -27.4 -24.2 -25.1 -28.9 -30.8 -28.2

15.3 11.5 5.7 3.0 2.9 1.4 -3.6 -4.0 -4.4 -8.4

Weight*

11.7 15.9 7.0 -1.9 -1.7 1.6 0.6 -3.2 -5.1 -2.5

3.7 3.2 5.2 5.2 26.1 12.0 13.4 15.3 5.2 11.9

25 HC CS

20 15

CD IT TC MT 10 FN EN IN 5 0

__Asia Pacific___ 2008 2009 15.7 10.4 10.3 10.9 26.3 14.8 21.6 10.7 12.4 396.9

50 100 150 EPS growth 2008-09 (%)

200

Source: I/B/E/S, HSBC

4. Consensus EPS growth (%) by sector

15.6 4.3 2.2 2.1 -0.1 -5.1 -9.1 -10.0 -11.1 -72.4

UT

30

0

Notes: * = in MSCI Asia Pacific; 3M and Y-t-d data up to 22 Sep 2008 Source: Bloomberg, HSBC

Energy Consumer staples Financials Industrials Materials Technology Health Care Telecoms Consumer disc Utilities

35

12M PE

%

3. PE vs 2007-9 growth, Asia ex-Japan sectors

5. Consensus PE (x)

__Asia ex-Japan__ 2008 2009 14.2 -6.8 4.6 -8.4 5.2 -14.5 8.8 -13.9 15.6 -20.7

23.3 11.6 13.6 19.5 4.1 14.6 16.0 14.1 11.3 0.9

Source: I/B/E/S

__Asia Pacific___ 2008 2009 Utilities Health Care Consumer staples Technology Financials Consumer disc Telecoms Energy Industrials Materials

97.1 20.3 18.3 14.1 12.4 12.3 12.2 10.4 10.2 10.1

__Asia ex-Japan__ 2008 2009

19.5 16.7 16.6 12.3 11.3 10.9 11.1 9.0 9.2 8.0

17.1 18.5 14.9 13.0 11.9 10.8 12.1 9.5 11.1 7.3

16.9 16.0 13.4 11.3 10.5 9.7 10.6 7.7 9.3 7.0

Source: I/B/E/S

6. MSCI Asia Pacific cyclical sectors vs Manufacturing ISM index

7. Semiconductor shipment vs MSC Asia Pacific IT sector

80%

65

60%

60

40%

60%

200% 150% 100%

40% 20%

55

0%

50

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

-20%

MXAP Cyclicals

Manu ISM (RHS)

40

-50% -100%

-40%

Source: HSBC, Bloomberg

66

0%

45

-40% -60%

50%

0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

-20%

20%

Semicon shipment val y/y -60% Source: WSTS, Bloomberg

MXAP IT Index y-o-y (RHS)

-150% -200%

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Equity Strategy Asia Pacific Fourth Quarter 2008

Accordingly, we stay overweight telecoms and healthcare. We raise utilities from neutral to overweight, particularly since in China the squeeze on profits from higher coal prices should end. We remain squarely underweight IT, financials and consumer discretionary. Our main change this quarter is to raise industrials from underweight to overweight, and to cut consumer staples from overweight to neutral. We believe that infrastructure spending is likely to hold up better than consumer spending in the slowdown in coming quarters. Moreover, valuations in consumer sectors have got stretched; those in capital goods now look cheap.

Utilities

What we like

As US consumers curtail spending, end demand is likely to fall further. This will hurt all areas of technology, even handsets and notebook PCs which have been strong this year. Inventories are now being dramatically purged; this could overshoot in Q1, cutting production even further. The pain will be felt all along the supply chain, from DRAM makers to semiconductor production equipment.

Telecoms

There are markets we would avoid (for example, China because of the ongoing telecoms restructuring, or Korea because of excess competition) but we see generally telecoms as a relatively safe bet. Subscriber growth and ARPUs are likely to remain resilient in markets such as India and southeast Asia. Capital goods

We see infrastructure spending holding up well, and even being increased in markets such as China, Korea, Taiwan and Indonesia as politicians try to offset slowing economic growth. This is a somewhat more risky sector, particularly since corporate capex will be at risk. But the valuations for long-cycle capex plays, especially in China and India, are now looking compelling, with the sector in Asia ex Japan on only 9x next year’s earnings. Healthcare

This is only a small sector but the combination of structural growth (as Asia’s population ages and drugs companies get better at developing their own compounds) and defensiveness is an attractive one in the current environment.

A classic defensive sector, with generally high dividend yields. In China, freer domestic energy prices and falling coal costs will help profits to recover. Energy

While we do not expect the price of crude to rise, there should be a rebound in refiners and retail oil marketers that have been hurt by government controls or by artificially low domestic oil prices. This is particularly the case for China.

What we don't like Technology

Financials

In a number of Asian financial markets, mini credit crunches threaten. This is most true in Korea, India, Australia and Taiwan. NPLs are likely to rise and margins be squeezed for some banks by higher funding costs. In China, regulators appear to be trying to limit banks’ profit growth to help the broader economy. While Asia’s problems are nothing like as big as those in the US or Europe, this is not a sector to have too much exposure to in a cyclical downturn. Consumer discretionary

Consumers in the US and Europe are unlikely to be increasing their spending on the cars and electronic gadgets that Asia specialises in. Moreover, while not as bad as in the US, Asian consumers – particularly in Korea, Hong Kong, Singapore and Taiwan – are likely to tighten their belts, too.

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Resources

We do not expect metals prices to fall that much further, but supply is starting to increase for iron ore and copper, in particular, and this means that prices are unlikely to rebound either. Analysts have yet to fully reprice their earnings estimates to take into account the new world of lower commodities prices and so true valuations are not as cheap as the headline numbers suggest. Real estate

A combination of higher funding costs, balancesheet worries and nervous consumers is not a good environment for property developers. Chinese house prices have started to fall quite sharply, and we expect those in Hong Kong to come down 10% or so over the next 12 months. Korea faces a mini-crisis in its housing market. Prices are likely to be weak in Singapore, Taiwan and Australia. This is a sector to avoid for now.

Quantitative scorecards The scorecards focus on three broad sector attributes, which loosely correspond to momentum, growth and value investing: price momentum (eg change in share prices over one and three months), earnings momentum (eg change in IBES forecasts) and valuation (a DDM that backs out implied earnings growth). For each of these three attributes, we rank the 10 MSCI sectors, and average the ranking to produce an overall consolidated score. This is a method that is concise and consistent over time. We use the scorecards to help formulate our sector recommendations, although not slavishly: judgemental considerations are more important. At the moment, the sector scorecards largely concur with our qualitative judgements. Telecoms, energy and healthcare are the three top scoring sectors for Asia ex Japan; we are overweight or neutral on all of them. Consumer discretionary and IT, on both of which we are underweight, score worst. Only our bet to lower exposure to consumer staples and raise exposure to industrials is contrary to these quantitative indicators. That points to the fact that we are trying to call a turning point for these, while the quants scorecards generally indicate momentum, whether of share prices or earnings.

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Scorecards 8. Asia ex-Japan ___ Price momentum ______ Now 1M chg 3M chg Telecommunication Services Energy Health Care Consumer Staples Financials Utilities Materials Industrials Consumer Discretionary Information Technology

6 4 2 3 5 1 7 10 8 9

2 -3 2 2 1 1 -4 -1 2 -2

-1 0 1 5 4 5 -5 0 -1 -8

___ Earnings momentum ___ Now 1M chg 3M chg 1 3 4 1 7 9 6 8 5 10

7 -2 2 1 2 -6 -1 -1 -1 0

9 -1 1 5 0 -1 -3 0 -2 -9

________Valuation ________ Now 1M chg 3M chg 1 3 4 7 1 6 9 5 10 8

0 0 2 0 0 -1 1 -1 -1 0

1 4 1 -1 0 -3 1 -2 -1 0

_____ Consolidated________ Now 1M chg 3M chg 1 2 2 4 5 6 7 8 8 10

5 -1 2 -1 -1 -4 0 0 1 0

4 0 0 5 0 -1 -3 2 0 -9

Source: HSBC

9. Australia ___ Price momentum ______ Now 1M chg 3M chg Energy Healthcare Information Technology Utilities Materials Consumer Staples Telecommunication Services Consumer Discretionary Financials Industrials

2 3 3 1 10 5 9 6 7 7

4 3 -2 1 -2 -2 -6 4 2 -4

-1 3 0 1 -7 2 -4 4 2 1

___ Earnings momentum ___ Now 1M chg 3M chg 1 4 2 6 3 6 5 10 8 8

2 1 1 0 -2 0 -4 -1 2 0

6 1 0 2 2 -3 -4 -1 2 -4

________Valuation ________ Now 1M chg 3M chg 7 6 10 8 3 5 2 1 3 8

0 -1 0 -1 2 -1 0 0 -1 1

-1 3 0 0 2 -3 2 1 -2 -2

_____ Consolidated________ Now 1M chg 3M chg 1 2 3 3 5 5 5 8 9 10

5 4 0 2 -2 -3 -4 0 1 -2

3 6 2 3 -2 -3 -4 2 -1 -4

Source: HSBC

10. China ___ Price momentum ______ Now 1M chg 3M chg Consumer Staples Financials Information Technology Utilities Energy Industrials Materials Consumer Discretionary Telecommunication Services

2 4 3 1 5 7 9 5 7

1 -1 -2 0 0 -2 0 3 -2

-1 0 2 1 -3 1 -3 4 0

___ Earnings momentum ___ Now 1M chg 3M chg 2 3 1 8 3 8 6 5 7

2 -2 0 1 2 -1 2 -2 -1

2 5 2 1 3 -4 0 -3 -6

________Valuation ________ Now 1M chg 3M chg 5 2 9 4 7 1 3 8 5

1 0 0 -1 0 0 1 0 -1

0 -1 0 -3 0 0 2 0 -1

_____ Consolidated________ Now 1M chg 3M chg 1 1 3 3 5 6 7 7 9

2 0 -1 0 2 -3 2 1 -3

0 3 4 -1 1 -2 0 2 -7

Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

11. Hong Kong ___ Price momentum ______ Now 1M chg 3M chg Industrials Financials Utilities Consumer Discretionary Telecommunication Services Materials Information Technology

3 4 1 5 2 8 5

3 0 0 -1 0 -1 -3

0 1 3 0 0 -1 -4

___ Earnings momentum ___ Now 1M chg 3M chg 1 1 3 4 4 6 7

1 6 -1 0 -3 2 -3

3 4 0 2 -3 2 0

________Valuation ________ Now 1M chg 3M chg 4 3 4 2 7 1 6

2 -1 0 0 0 0 -2

2 -1 0 1 0 0 -1

_____ Consolidated________ Now 1M chg 3M chg 1 1 1 4 5 6 7

5 4 0 -2 -3 1 -5

3 2 1 2 -4 1 -3

Source: HSBC

12. India ___ Price momentum ______ Now 1M chg 3M chg Health Care Energy Consumer Discretionary Utilities Consumer Staples Information Technology Telecommunication Services Materials Financials Industrials

3 5 1 5 1 4 9 9 7 8

0 -2 4 -4 0 4 0 1 -2 -3

-2 1 3 3 2 -3 -5 -3 2 1

___ Earnings momentum ___ Now 1M chg 3M chg 2 4 3 6 8 1 4 7 9 9

0 -1 5 -5 0 3 1 -2 -2 1

0 -3 2 -1 -3 2 5 -3 -4 1

________Valuation ________ Now 1M chg 3M chg 3 1 8 2 5 9 3 6 7 10

-1 0 0 2 -1 0 -1 0 0 0

0 0 -1 3 -3 0 1 0 0 0

_____ Consolidated________ Now 1M chg 3M chg 1 2 3 4 5 5 7 8 9 10

1 0 4 -3 -1 2 -2 -1 -3 0

0 0 2 4 -2 -1 0 -3 0 0

Source: HSBC

13. Japan ___ Price momentum ______ Now 1M chg 3M chg Telecommunication Services Health Care Industrials Energy Information Technology Consumer Discretionary Consumer Staples Materials Utilities Financials Source: HSBC

70

1 3 6 5 4 8 2 9 7 10

4 -2 -4 -1 -1 0 5 -3 2 0

8 2 -4 -4 -1 -2 5 -5 3 -2

___ Earnings momentum ___ Now 1M chg 3M chg 1 5 2 3 5 4 9 7 10 8

0 -3 2 6 2 -1 -4 -1 -1 0

5 -3 -1 0 -1 5 -2 -2 0 -1

________Valuation ________ Now 1M chg 3M chg 4 1 2 3 6 4 7 8 9 10

3 0 2 -1 -1 -2 -2 0 0 0

3 0 2 -1 -1 -2 -2 0 0 0

_____ Consolidated________ Now 1M chg 3M chg 1 2 3 4 5 6 7 8 9 10

2 -1 -1 1 0 -3 0 0 0 0

7 1 -1 -3 -1 -1 0 -3 1 -1

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Equity Strategy Asia Pacific Fourth Quarter 2008

14. Korea ___ Price momentum ______ Now 1M chg 3M chg Consumer Staples Materials Energy Telecommunication Services Consumer Discretionary Financials Utilities Information Technology Industrials

1 5 7 2 6 4 3 8 9

0 -2 0 3 -3 2 -1 1 -1

2 -4 -4 5 -3 3 4 -5 -7

___ Earnings momentum ___ Now 1M chg 3M chg 4 1 2 8 3 4 9 4 4

-1 1 4 0 1 1 -2 6 4

-2 3 7 -1 2 2 1 -3 4

________Valuation ________ Now 1M chg 3M chg 3 4 2 1 5 6 7 8 9

0 0 0 0 0 1 -1 0 0

-1 1 2 0 -2 0 -1 0 0

_____ Consolidated________ Now 1M chg 3M chg 1 2 3 3 5 5 7 8 9

0 0 2 1 -2 2 -2 1 -1

0 0 3 2 -2 2 2 -4 -2

Source: HSBC

15. Singapore ___ Price momentum ______ Now 1M chg 3M chg Financials Health Care Telecommunication Services Industrials Consumer Discretionary Consumer Staples Information Technology

3 4 1 4 2 7 6

-2 2 3 -2 3 -1 -3

0 3 5 -2 1 -6 -3

___ Earnings momentum ___ Now 1M chg 3M chg 1 5 2 3 6 4 7

0 2 1 1 -2 -2 -3

2 2 1 0 2 -3 -1

________Valuation ________ Now 1M chg 3M chg 2 1 7 4 6 4 3

0 0 0 0 -2 2 0

0 0 -1 1 -3 2 0

_____ Consolidated________ Now 1M chg 3M chg 1 2 2 4 5 6 7

0 3 3 -2 -1 -1 -5

0 4 4 -1 0 -5 -3

Source: HSBC

16. Taiwan ___ Price momentum ______ Now 1M chg 3M chg Telecommunication Services Materials Energy Consumer Staples Consumer Discretionary Information Technology Financials Industrials

1 6 2 4 5 3 6 8

0 0 -1 -1 0 0 2 -1

1 0 0 1 2 -2 -4 -1

___ Earnings momentum ___ Now 1M chg 3M chg 4 2 1 5 2 7 8 5

-3 3 6 -4 -1 -2 -4 3

0 -1 7 -4 -1 -3 -2 2

________Valuation ________ Now 1M chg 3M chg 3 1 7 3 6 5 2 8

0 0 0 0 0 0 0 0

0 0 0 0 -1 -3 3 0

_____ Consolidated________ Now 1M chg 3M chg 1 2 3 4 5 6 7 8

0 1 4 -2 -2 -1 -1 0

2 0 4 -1 0 -5 -2 0

Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Top stock picks  We showcase names our analysts have strong views on that fit

with the strategy team’s sector and market preferences  Our buy list consists mainly of large-cap, blue-chip names  Top sells concentrated on technology companies and banks

What to buy – and what not The tables below highlight our highest conviction buy and sell recommendations in Asia-Pacific. They were chosen by the strategy team from among our analysts’ top (in terms of potential upside or downside to target price) large-cap picks with reference to the markets or sectors where the strategy team has overweight or underweight

calls. A short note on each stock, with full valuation metrics and investment risks, follows. Favourite buys

We stick to a solid, no-surprises list (Table 1). The stocks included are all liquid, large-cap names, with solid balance sheets, good long-term prospects for earnings growth and quality managements. We have avoided most cyclical

1. HSBC’s top high-conviction buy ideas Code

Name

836 HK 857 HK 2727 HK 823 HK 19 HK BHARTI IN LT IN 9433 JP 033780 KS SIA SP

CHINA RESOURCES POWER HOLDIN PETROCHINA CO LTD-H SHANGHAI ELECTRIC GRP CO L-H LINK REIT SWIRE PACIFIC LTD 'A' BHARTI AIRTEL LIMITED LARSEN & TOUBRO LIMITED KDDI CORP KT&G CORP SINGAPORE AIRLINES LTD

Country/ region

Sector

CH CH CH HK HK IN IN JP KR SG

Utilities Energy Industrials Real estate Industrials Telecoms Industrials Telecoms Consumer Airlines

Country/ region

Sector

CH IN JP JP KR TW

Airlines Financials Financials IT Telecoms IT

HSBC rating Upside to target price (%) Overweight (V) Overweight (V) Overweight (V) Overweight Overweight Overweight (V) Overweight (V) Overweight Overweight Overweight

51.6 48.4 66.7 27.7 45.7 23.6 29.5 47.2 17.9 28.9

Price Market (local curr) cap 27 Jun (USDm) 17.02 (HKD) 9,175 8.56 (HKD) 197,430 2.40 (HKD) 6,262 16.84 (HKD) 4,683 70.00 (HKD) 8,248 810.55 (INR) 33,486 2,550.55 (INR) 16,228 598,000.00 (JPY) 25,295 89,100.00 (KRW) 10,864 14.74 (SGD) 12,287

Source: HSBC

2. Top sell ideas Code

Name

670 HK ICICIBC IN 8316 JP 8035 JP 017670 KS 3009 TT

CHINA EASTERN AIRLINES - H ICICI BANK LTD SUMITOMO MITSUI FINANCIAL GR TOKYO ELECTRON LTD SK TELECOM CHI MEI OPTOELECTRONICS CORP

Source: HSBC

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HSBC rating Upside to target price (%) Underweight (V) Underweight (V) Underweight (V) Underweight (V) Underweight Underweight (V)

Price (local curr)

Market cap (USDm)

-62.4 1.33 (HKD) -5.0 600.10 (INR) -26.9 684,000.00 (JPY) -14.0 5,510.00 (JPY) -15.0 203,500.00 (KRW) -20.4 22.60 (TWD)

962 14,537 50,906 9,352 12,963 5,159

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Equity Strategy Asia Pacific Fourth Quarter 2008

sectors, and also stocks in markets such as Taiwan and south-east Asia, which we see as high risk. In more cyclical markets such as Korea, we have stuck to solid, defensive names.

 Bharti Airtel, a good example of a long-term growth story now trading on attractive valuations.

On our high-conviction buy list, we retain five stocks (Swire Pacific, Larsen & Toubro, KDDI, KT&G and Link REIT) from previously.

Table 2 shows our highest-conviction sell ideas. These generally reflect our nervousness about (1) balance sheet risk, (2) funding issues for banks in certain markets, and (3) the risk of a US consumer slump hurting the IT sector.

We have dropped the following stocks:  ICBC (1398 HK, Overweight (V), HKD4.66) because we downgraded Chinese banks to neutral on worries that the authorities will try to limit their profitability.  Simcere (SCR US, Overweight (V), USD10.15) which, with a market cap of less than USD1bn, has got too small.  Wumart (8277 HK, Overweight (V), HKD6.44) since we have downgraded the Chinese consumer staples sector on fears that consumption might slow.  Dong-A Pharmaceutical (000640 KS, Overweight, KRW102,000) because we

Sell ideas

We dropped the one sell idea from last quarter, coal producer China Shenhua Energy (1088 HK, Underweight (V), HKD22), which has already fallen substantially. We added Tokyo Electron and Chi Mei on expectations that demand for electronics products will slow sharply; China Eastern on worries about its balance sheet and long-term future; ICICI in India and Sumitomo Mitsui in Japan on concerns about funding issues and rising NPLs; and Korea’s SK Telecom, where we see excess competition for new subscribers denting profits until the end of 2009.

ceased coverage of the healthcare sector Our additions this quarter are:  Singapore Airlines, a blue-chip name which should additionally benefit from lower oil prices.  Petrochina, which we think will benefit from the falling crude price, relaxation of government energy price restrictions, and the buyback plan of its parent.  China Resources Power to give us exposure to the defensive utilities sector where we see profitability rebounding as coal prices fall.  Shanghai Electric, since we see infrastructure spending in China being stronger than consumption. This stock has got very cheap, and retains excellent long-term potential.

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CR Power (836, OW/V)  Preferred pick among China IPPs given strong capacity expansion

and track record  Coal mine investment to prolong earnings growth longer term.

Another tariff hike before 2008 could be the catalyst in short term  Rating Overweight (V); target price HKD25.80

CR Power’s performance in 1H2008 is the most resilient to surging coal prices among HK-listed IPPs (earnings declined 29% yoy compared to 78% for Datang and losses for Huaneng, Huadian and China Power), mainly due to stronger management and fuel cost control. Based on its greenfield project development schedule, attributable capacity will increase from 13GW in 2007 to 20GW by 2010e. Management is confident it will meet the target, and it could be exceeded if more acquisitions are done in future. We expect its profit margin to expand once coal mine projects commence operation in 2010e, hence prolonging earnings growth longer term.

Valuation and risks

According to management, the government may raise the on-grid tariff once more before end of 2008. This could be the share price catalyst for CR Power and the other IPPs in the near term.

Key downside risks to our target price and earnings estimates are: (1) a surge in coal costs, and (2) any delay in commissioning of upstream investments or lower-than-expected returns.

Our target price of HKD25.80 is based on a sumof-the-parts DCF valuation (HKD18.72 per share for its power projects and HKD7.08 per share for upstream investments). Given CR Power’s coal business should start to contribute in 2010 and be fully operational in 2013, CR Power is currently trading at a 2009e PE premium to its peers. If we strip out the value of its upstream businesses from the current price, the PE of its core power assets would be 8x in 2009e, with a high 2008-10e EPS CAGR of 26%, which looks attractive compared to its peers (2009e PE of 9-14x and 2008-10e EPS CAGR of -6% to 18%).

Gary Chiu* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4297 [email protected] Scully Tsoi* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6620 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Key financials & valuation Share price: (HKD) 16.58 Year to 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (HKDm) 69,375

Net sales (HKDm)

HSBC EBIT (HKDm)

HSBC net profit (HKDm)

HSBC EPS (HKD)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

16,830 26,749 37,358 41,358

3,955 4,283 6,891 10,241

3,190 2,731 4,656 6,764

0.81 0.66 1.12 1.63

33.7 -18.8 70.5 45.3

20.4 25.1 14.7 10.1

1.5 1.3 2.2 3.2

15.9 10.6 16.4 20.6

2.8 2.6 2.3 1.9

Notes: Price at close of 01 Oct 2008. * = Based on HSBC EPS (fully diluted) Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

PetroChina (857, OW/V)  1H08 result in line, we believe 2H08 will be better on lower crude

price and product price hike  Transfer of upstream assets from parent to drive production growth  Valuation looks attractive, with 09e PE at 8x and 50% discount to

equity replacement value. Rating Overweight (V); target HKD12.7

1H08 net profit was down 34.5% YoY, largely due to widened refining loss on rising oil prices in 1H. We believe PetroChina will be able to improve earnings significantly in 2H on lower crude prices and higher product prices after price hike on June 19th. On our estimates, the refining segment will break even with oil at USD100/bbl. PetroChina announced acquisition of a 51.89% interest in CNPC (HK) from its parent, CNPC, in order to gain synergy on upstream and city gas business. In addition, the chairman confirmed that acquisition of a 50% interest in CNPC E&D is just a matter of time. One of the highlights in the 1H08 result is that overseas production grew 2ppts to 7%. We believe asset transfer from the parent will make overseas upstream business a new engine to drive production growth.

Valuation and risks We set our price target of HKD12.7 based on the average of 1) a PE multiple of 12x, which is derived by applying a 25% discount (i.e. average 1-year P/E differential between PetroChina and the MSCI China Index) to HSBC 12-monthforward target PE of 16x for MSCI China; and 2) DCF per share estimate of HKD12.50 using a long-term normalized oil price of USD61/bbl and 12% discount rate.

Steven Li Hong Xing* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6941 [email protected]

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

Key catalysts are M&A activity, reduction of windfall tax, and major discoveries. Key risks include highly volatile crude oil price, declining production growth and slowdown in China oil product demand.

Key financials & valuation Share price: (HKD) 8.14

Market cap: (HKDm) 1,457,231

Year to

Net sales (RMBm)

HSBC EBIT (RMBm)

HSBC net profit (RMBm)

HSBC EPS (RMB)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

12/2006a 12/2007e 12/2008e 12/2009e

688,978 835,037 1,108,428 896,519

198,050 198,989 191,578 229,602

142,224 145,625 139,438 164,595

0.79 0.81 0.76 0.90

5.3 2.0 -6.0 18.0

9.2 9.0 9.5 8.1

4.9 4.9 4.7 5.6

25.8 22.1 17.8 18.5

2.2 1.8 1.6 1.4

Notes: Price at close of 02 Oct 2008

* = Based on HSBC EPS (fully diluted) Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Shanghai Elec (2727, OW/V)  Pressure on earnings to subside from 2H09 as commodity prices

retreat from 2008 peaks  Likely to benefit from investment in domestic infrastructure  Only HK-listed Chinese conglomerate play with sufficient liquidity.

Rating Overweight (V); target price HKD4.00

Peak commodity prices in mid-2008 will have a greater impact in 2H, but we expect incremental raw material cost, if any, to be minimal in 2009 and EBIT margin to recover as material costs ease. Material cost pressure is expected to ease from 2H09, when y-o-y comparisons will benefit from the difficult FY08 and 1H09 numbers. New orders of power generation equipment in 1H08 totalled cRMB60bn (77% of 2007 orders), boosting backlog to over 90GW. As China looks towards upgrading its infrastructure as a way to boost the overall economy, Shanghai Electric stands to benefit from any increased spending on domestic alternative power generation capacity, rail transportation and heavy machinery. The shift towards larger power generation equipment is another positive catalyst, given the higher pricing the company can achieve on these large units. We

believe Shanghai Electric is a defensive longcycle domestic infrastructure play in a likely worsening economic environment.

Steve Man* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4395 [email protected]

Valuation and risks

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

Our Overweight (V) rating and price target of HKD4.00 are based on a target MACC of 24%, ACROIC of 9%, 12.1x our 2009e earnings and 2.0x forward PB. Shares are currently trading at 7.1x 2009 earnings and 1.1x forward PB. Historically, the stock has traded at a minimum PE of 11.3x and minimum forward PB of 1.4x. Risks to our rating: economic slowdown, stock market decline, greater capacity addition than expected and material cost increases. Margins could be depressed by potential lower pricing for overseas orders and new products.

Key financials & valuation Share price: (HKD) 2.31 Year to 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (HKDm) 27,470

Net sales (CNYm)

HSBC EBIT (CNYm)

HSBC net profit (CNYm)

HSBC EPS (CNY)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

56,437 63,333 74,101 73,630

3,338 3,820 5,061 5,585

1,629 2,436 3,621 4,074

0.14 0.22 0.29 0.33

9.3 60.6 31.6 12.5

15.1 9.4 7.1 6.3

2.2 2.9 3.2 5.1

9.2 12.3 16.2 16.0

1.3 1.2 1.1 1.0

Notes: price at close of 01 Oct 2008 * = Based on HSBC EPS (fully diluted) Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

The Link REIT (823, OW)  Largest retail landlord with diversified and defensive tenant base;

a low risk play amid market uncertainties  Highest trading liquidity and one of only two clean REITs in Hong

Kong  Target price of HKD21.5, coupled with DPU yield of 5.2%, imply

potential total return of 40%, Overweight rating

Strategically located, diversified and defensive retail portfolio. The Link REIT (Link) holds a diversified portfolio of 180 properties across eight main geographical districts in Hong Kong. The Link’s portfolio is by far the most diversified in Hong Kong and its dominant market presence positions it well and helps with leasing both in terms of volume and economics. Furthermore, Link has a defensive tenant base, a key investment attribute in the midst of global market uncertainties. As of 31 March, Link’s trade-mix comprised 53% F&B, supermarket and foodstuff, and cooked food stalls.

likely among the sector leaders.

Valuation and risks Our TP is based on Link’s historical average price/distribution multiple of 26x and is derived using our 2008/09e DPU of HKD0.83. This TP, coupled with a dividend yield of 5.2%, implies potential total return of 40%. We believe Link units should be a core holding in any long-term REIT portfolio.

Michelle Kwok* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6918 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Key risks include high lease expiry over the next three years, political/social-economic issues, and downturn in retail markets where Link has a significant presence.

Highest DPU growth among H-REITS. In the year ending March 2008, Link posted DPU growth of 10%, 300bp higher than the average 7% achieved by its peers in FY07. Our HKD0.83/unit DPU growth reflects 12% y-o-y growth and is

Financial highlights YE March FY08 FY09e FY10e FY11e

Revenue (HKDm)

NOI (HKDm)

DPU

p/distribution (x)

DPU yield

4,199 4,569 4,871 5,094

2,537 2,700 2,871 2,980

0.74 0.83 0.90 0.94

21.4 19.2 17.6 17.0

4.7% 5.2% 5.7% 5.9%

Source: Company data, HSBC forecast

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Equity Strategy Asia Pacific Fourth Quarter 2008

Swire Pacific (0019, OW)  Swire Properties earnings and valuation remain defensive given

constrained supply and low HK interest rates  FY08e recurring net profit lowered 19% due to Cathay Pacific. We

expect the airline to return to profit in 2H08  Valuation compelling. Discount to NAV to contract given decent

HK growth and low interest rates. Rating OW; target HKD102

Swire Properties outlook strong. Forward indicators for office property have weakened. However, we expect this cycle to be supported by constrained supply, high nominal GDP growth and low interest rates. While we expect office property values to slide over the next year, we do not expect a significant decline. With only 20% of space up for renewal in FY09e, the earnings outlook is strong and low risk. Earnings downgrades driven by Cathay Pacific. While Properties and Marine Services performed better than we expected in the first half, Cathay Pacific was worse and we recently cut our FY08e recurring net profit by 19%. We expect Cathay to return to profitability in 2H08.

Valuation and risks Our appraised valuation is HKD120 per share and we set our target of HKD102 at a 15% discount; we expect the current discount to contract due to negative real interest rates in Hong Kong. Our valuation is sensitive to property values and Cathay Pacific’s target price. We rate Swire Pacific stock Overweight.

Mark Webb* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6574 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Catalysts are falling Fed Funds rate expectations and lower aviation risks. HSBC’s forecast of a Fed Funds rate of 2.0% until 4Q09 is c75bps below the level implied by Fed Fund futures. We expect falling interest rate expectations to be positive for Swire. In addition, we expect Cathay’s return to profit will lower the perceived risk of the aviation division, which makes up 18% of our appraised valuation.

Key financials & valuation Share price: (HKD) 67.40 Year to 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (HKDm) 61,642

Net sales (HKDm)

HSBC EBIT (HKDm)

HSBC net profit (HKDm)

HSBC EPS (HKD)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

21,687 24,889 27,145 28,594

6,055 7,418 8,523 9,288

8,653 7,495 10,039 12,161

5.69 4.94 6.62 8.02

25.9 -13.1 34.0 21.1

11.9 13.6 10.2 8.4

4.8 4.8 4.9 5.9

6.9 5.3 6.7 7.9

0.8 0.7 0.7 0.6

Notes: Price at close of 01 Oct 2008. * = Based on HSBC EPS (fully diluted) Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Bharti Airtel (BHARTI, O/V)  Accelerated subscriber growth gives Bharti scale benefits, makes

it eligible for more spectrum and keeps new entrants in check  Receipt of 3G spectrum will allow Bharti to consolidate market

leadership but regulatory uncertainty remains  Rating Overweight (V); target price INR1,002

Bharti remains our top pick in the Indian telecom space. Receipt of 3G spectrum would aid Bharti in consolidating market leadership. We hold that a move to 3G will kick start the consolidation process in India as it will expose financial, structural and operational weaknesses of smaller operators in an overcrowded market. Strategically, Bharti faces two challenges; one is spectrum and other is the regulatory uncertainty, created by a host of new entrants. We believe Bharti’s market share focus addresses spectrum constraints as it allows being eligible for additional spectrum. Notably Bharti has managed spectrum in 8 additional markets and is eligible in another 6 markets. Net additions for August highlighted another month of outperformance. Further the market share focussed approach has not only enabled it to assume scale, but also has allowed it get aggressive on pricing (evident from the price cuts on the NLD side) and make rollout unattractive for new entrants.

Valuation and risk We value the stock using DCF-based SOTP. We use a WACC of 11% which includes COE 12%, Cost of Debt 9% and Beta 1x. Our bullish investment thesis is based on a combination of expected sharp growth in the Indian wireless market, outstanding execution of a low-leverage, low-cost business model with a high return on invested capital, and a close alignment of majority and minority shareholder interests. Bharti continues to post financials that beat consensus estimates, increase its market share in a rising market, and successfully monetize tower assets in difficult market conditions.

Rajiv Sharma* Analyst HSBC Securities and Capital Markets (India) Private Limited +91 22 2268 1239 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Principal risks for the stock would be upward revision of subscriber-based criteria for additional spectrum, hikes in spectrum charges, aggressive international expansion strategy and higher than estimated capex. While we are confident on Bharti’s earnings growth, a key concern has been the government’s policy of squeezing the sector by raising taxes and micro managing the sector via frequent revisions to longer term policy.

Key financials INRm FY09e FY10e

Revenue EBITDA Margin 384,838 473,164

37.3 36.3

PAT EPS Growth % 83,950 106,683

31.1 28.0

P/E*

EV/EBITDA*

RoE %

18.0 14.0

10.6 8.9

36.0 32.9

*Price as at close of 2 Oct 2008 Source: HSBC estimates

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Equity Strategy Asia Pacific Fourth Quarter 2008

Larsen & Toubro (LT, O/V)  Still the key beneficiary of infrastructure spending in India  Vertical diversification into power, railways and shipbuilding along

with international business to mitigate any near-term challenges  Strong balance sheet and ability to manage interest expense

make it preferred choice; rating OW(V), target INR1,650

L&T is diversifying into sectors such as power equipment manufacturing, railways, hydrocarbon, and shipbuilding to offset any near-term challenges. It has developed a portfolio of assets across various verticals like roads, ports, airports and urban infrastructure; these projects could become an important earnings driver over the next 2-3 years. L&T has also increased its focus on international business (20% revenue in FY08) to offset any challenges in the domestic market. Revenue growth is driven by the strong order backlog. Management guides to 30-35% revenue growth and 30% order inflow in FY09, with sustainable margins and focus on higher margin business. Process industries and the oil and gas sector contributed 40% of L&T’s new orders in FY08 compared to 29% in FY07. The margin in these sectors is c13-14% versus 9-10% in power and infrastructure. L&T is focusing on large orders in the range of INR1-1.5bn compared to INR200-

500mn earlier, and orders with price variation clause (“PVC”, currently 65% of the order book) to sustain its margins in an environment of rising commodity prices. L&T plans to use its strong balance sheet to raise funds overseas, which should help it to offset the impact of rising interest rates.

Valuation and risks Our target of INR1,650 is based on MACC valuation methodology. We expect L&T to trade at MACC of 9.5-12.5% and CROIC of 8.4-9.5%. L&T is trading at 19.5x FY10e EPS of INR62.4 on a standalone basis, without factoring in the value of any of its other businesses (valued by us at INR314 per share). At our target, L&T’s core business would trade at 21.5x FY10e earnings. Execution delay is a key risk; rising raw material prices and interest rates will impact profitability.

Key financials

FY 2009e FY 2010e

Revenue (INRmn)

EBITDA margin (%)

PAT (INRmn)

EPS growth (%)

PE* (x)

EV/EBITDA* (x)

RoE (%)

323,620 426,559

11.10% 11.50%

26,909 36,512

34.90% 35.40%

26.4 19.5

19.1 13.6

27.20% 29.40%

Note: * = price as at close of 02 October 2008 Source: HSBC estimates

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Sumeet Agrawal* Analyst HSBC Securities and Capital Markets (India) Private Limited +91 22 2268 1243 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

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Equity Strategy Asia Pacific Fourth Quarter 2008

KDDI (9433.JP, OW)  March 09 OP better than guidance on lower commission costs: we

estimate JPY461bn (KDDI at JPY443bn)  Near-term boost from 1Gbps fibre service launch, but medium-

term trends remain tough  TP of JPY750k: low capex in mobile and low overall leverage

enhance defensive qualities – relative outperformance to continue

Operating profit to rise in FY Mar-09

remain under pressure.

The launch of the ‘au purchase plan’ in June 2008 should reduce commission costs: we forecast FY Mar-09 operating profit at JPY461bn (company guidance: JPY443bn). We expect the service to help reduce churn, but note that profits from communications will reduce over the mediumterm as a result of lower line rental charges under the au purchase plan.

Valuation: Our DCF based target price is JPY750,000. We believe KDDI has strong defensive qualities: it is no more than normally exposed to GDP trends, and net debt is just 0.7x FY Mar-09 EBITDA. The EV of 3.6x FY Mar-09 EBITDA is below the global telecoms aggregate of 4.6x. Risks: Risks are increased competitive intensity and price-cutting in the mobile sector (most likely driven by SoftBank). Increased investment in WiMAX equity-affiliate UQ Communications would be a negative, as would a too early move to next generation mobile (LTE) technology, which would reduce KDDI’s cost advantage.

Cut our long-term margin assumptions on weaker discretionary spending

We have reduced our long-term mobile and fixed margin assumptions by 2ppt, as a result of weaker discretionary spending in both the consumer and corporate segments. KDDI’s new 1Gbps service will increase detached household subscribers in urban Tokyo, but medium-term margins will

Neale Anderson* Analyst HSBC Securities (Japan) Limited +813 5203 3826 [email protected] Inder Kalra* Associate Bangalore *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Key financials & valuation Share price: (JPY) 590,000 Year to 2008e 2009e 2010e 2011e

Market cap: (JPYb) 2,695

Net sales (JPYbn)

HSBC EBIT (JPYbn)

HSBC net profit (JPYbn)

HSBC EPS (JPY)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

3,596 3,599 3,509 3,566

400 461 495 493

218 263 291 291

51,266 60,584 64,808 64,752

14.5 18.6 7.0 0.0

11.5 9.7 9.1 9.1

1.8 1.9 2.0 2.2

15 15 15 13

1.6 1.4 1.3 1.1

Notes: price at close of 3 October 2008. * = Based on HSBC EPS (fully diluted). Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

KT&G (033780, O)  Defensive stock with a record of solid growth  Temporary drop in 3Q08 export sales will not hurt fundamentals  Rating Overweight; target price KRW105,000

The stock’s defensive profile has led it to outperform the KOSPI by 75% over the last 12 months. The growth story remains intact, and we predict further outperformance over the next 12 months. Growth drivers. We project that KT&G will increase its cigarette sales at a CAGR of 8.2% over 2007-09 by raising ASP and aggressively expanding its presence in overseas markets. In addition, we forecast margin expansion due to decreasing use of relatively expensive domestic tobacco leaf. We expect the profit margin to rise from 33.8% in 2007 to 36.4% in 2009. Furthermore, the Korea Ginseng Company (100% owned subsidiary) should increase its contribution to group PBT from 14.2% in 2007 to 16.0% in 2009e via equity method gains. Overall, we expect a 14.8% EPS CAGR over 2007-09e. High shareholder return. Management culture has improved meaningfully, to the benefit of shareholders, in our opinion. The company has been buying back shares since August 2008 and

will cancel 1.9 million shares (1.4% of total outstanding shares) in November 2008. We anticipate a new shareholder-friendly plan for 2009 to be released by the end of this year.

Sean Yang* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4342 [email protected]

Temporary drop in export sales. Over the last month, the stock has dropped by 6%, and we think this is due to the slowing export sales. We expect 3Q export sales to grow only by 3% y-o-y as the company controlled volumes to prevent the export agent from stock-piling before renewing ASP on contract. However, we believe that this temporary drop will not hurt the company’s fundamentals and future earnings potential.

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

Valuation and risk Our 12-month target of KRW105,000 is based on a target PE of 16.2x applied to 2009e EPS and our sum-of-the-parts valuation, representing 19.6% potential total return. Key risk is slowing domestic cigarette consumption and cigarette tax hike expected in 2009.

Key financials & valuation Share price: (KRW) 90,300 Year to 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (KRWb) 12,709

Net sales (KRWb)

HSBC EBIT (KRWb)

HSBC net profit (KRWb)

HSBC EPS (KRW)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

2,413 2,640 2,873 3,170

814 954 1,041 1,168

662 802 881 993

4,838 5,864 6,441 7,259

9.0 21.2 9.8 12.7

18.7 15.4 14.0 12.4

2.9 3.3 3.9 4.3

21.4 25.3 25.7 25.4

4.1 3.9 3.4 3.0

Notes: price at close of 02 Oct 2008 * = Based on HSBC EPS (fully diluted) Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Singapore Airlines (SIA, O)  Outperformed MSCI Asia ex-Japan by 29% in the past 6 months  Most defensive and least cyclical Asian airline with best business

model  Rating Overweight; target SGD19, based on previous downcycles

Outperformer if growth slows. We argue Singapore Airlines (SIA) tends to outperform when perception of risk rises in Asia. Indeed, its share price has outperformed MSCI Asia ex-Japan by 29% in the past six months. Defensive business. SIA has a great brand and product, which are key drivers of airline returns in Asia. Singapore is the second best hub in Asia in terms of frequencies to key destinations. The airline has a balanced network and lucrative home base in terms of traffic mix. It has a flexible staff cost structure, with a modern and fuel efficient fleet.

Valuation and risks Overweight rating. In the past five market downturns in Asia since 1990 (we exclude the downturn from May 2002 due to the distortions of 9/11 and SARS), SIA’s P/BV has tended, on average, to fall 3% in the year after the market

peak, compared to its average in the year before the peak. If we apply SIA’s average annual P/BV decline to its average P/BV of 1.5x in the year to the MSCI AEJ peak in October 2007, this implies SIA should trade at 1.45x P/BV (which is in line with its average since 2000); this gives a fair value and our target price of SGD19. Meanwhile, we estimate replacement value for SIA is near its current share price levels.

Mark Webb* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6574 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Fuel price the key risk. SIA’s earnings are highly sensitive to small changes in assumptions, especially jet fuel prices. Other risks to our rating include expansion by the Arabian Gulf airlines on SIA’s key routes between Australia and Europe – although we argue that a high fuel cost environment reduces this prospect. Over the past year, SIA’s share price has had a 0.6x negative correlation with spot jet fuel prices.

Key financials & valuation Share price: (SGD) 14.22 Year to 03/2008a 03/2009e 03/2010e 03/2011e

Market cap: (SGDm) 16,871

Net sales (SGDm)

HSBC EBIT (SGDm)

HSBC net profit (SGDm)

HSBC EPS (SGD)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

15,972 18,207 18,234 19,567

2,124 1,711 1,546 2,185

2,049 1,523 1,531 2,035

1.69 1.29 1.29 1.72

42.2 -23.6 0.5 32.9

8.4 11.1 11.0 8.3

7.0 7.0 7.0 7.0

13.6 10.0 9.8 12.5

1.1 1.1 1.1 1.0

Notes: Price at close of 01 Oct 2008 * = Based on HSBC EPS (fully diluted)

Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

China Eastern (670, UW/V)  Premium valuation versus other PRC airlines unwarranted, given

loss-making business and over-stretched balance sheet  Further losses in 2008-09 would likely wipe out remaining

shareholders’ equity, in the absence of major fund-raising  HKD0.5 target is our end-08e accounting book value, which is

optimistic given negative replacement value; rating Underweight (V)

An overly risky business. China Eastern Airlines (CEA) is highly exposed to traffic slowdown, due to its brand and product weakness. We argue it will remain an underperformer even if the sector recovers. CEA also has a weak balance sheet. We estimate a 2008e net debt-to-equity ratio of more than 3,000% and contractual obligations in 200912 of over RMB30b.

Valuation and risks

Premium valuation unwarranted. At end-1H08, CEA’s post MI book value was only RMB0.57 per share. It is trading at 3.5x 2008e book value a huge premium to its peers. Our target price of HKD0.5 per share is our end-2008e book value.

Potential M&A an upside risk. A shortage of funds and negative cash flow could trigger equity tie-ups or restructuring, which are the major upside risks for this event-sensitive stock.

Negative replacement value. While the reduction in the RMB value of dollar debt is reported in the income statement as FX gain, the fall in the value of the dollar aircraft assets implies its book value is overstated. Therefore, even using its accounting book value of HKD0.5 implies, we believe, a relatively optimistic valuation assumption.

Eric Lin* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6570 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Key financials & valuation Share price: (HKD) 1.33 Year to 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (HKDm)

Net sales (RMBm)

HSBC EBIT (RMBm)

HSBC net profit (RMBm)

HSBC EPS (RMB)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

43,009 43,483 47,730 50,246

169 -2,570 -1,253 449

-1,456 -3,288 -2,484 -1,355

-0.30 -0.68 -0.51 -0.28

nm nm nm nm

nm nm nm nm

0.0 0.0 0.0 0.0

-49.8 -135.3 -154.1 -85.2

1.9 3.2 4.2 3.2

Notes: Price at close of 01 Oct 2008. * = Based on HSBC EPS (fully diluted) Source: HSBC nm = not meaningful

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Equity Strategy Asia Pacific Fourth Quarter 2008

ICICI Bank (ICICIBC, UW/V)  Profitability drivers have weakened by shift in asset mix and

sluggish domestic growth; rising credit costs a key risk  The stock has corrected sharply on concerns of exposure to

global financial markets through its overseas branches  Rating Underweight (V); target price of INR570

ICICI Bank’s (ICBK) loan growth nearly fell to 13% at the end of June 2008, after moderating through FY08. This was on the back of a sharp deceleration in retail advances (constituting c60% of the advances) on the back of a slowdown in most key segments. We believe weakening of growth drivers in the domestic market and increased focus on international lending when uncertainty persists in global markets could weigh on near-term profitability and sustainability. To add to this, the net NPA touched the 1.74% mark at end-June compared to 1.55% at end-March, highlighting the risk of rising credit costs. With a loan/deposit ratio of 92% at end-March 2008 and an inferior funding mix compared to peers (CASA at just 27%), much lower than even some of the state-owned peers, ICBK looks more vulnerable to margin pressures. The stock has corrected by c30% in the last month, on concerns of ICBK’s exposure to global financial markets through its UK subsidiary. The Bank has

clarified that only about 20% of the UK subsidiary’s investment book has exposure to the US. As on 30 June 2008, ICICI Bank UK had an investment book of USD3.5bn.

Todd Dunivant* Analyst The Hongkong and Shanghai Banking Corporation (HK) +852 2996 6599 [email protected]

Valuation and risk

Saumya Agarwal* Associate HSBC Securities and Capital Markets (India) Private Limited +91 22 2268 1235 [email protected]

We value ICBK using a combination of economic profit model (EPM), PE and P/B. We assume a risk-free rate of 9.5%, beta of 1.0 and cost of equity of 15.5% and we derive a value of INR558 under the EPM method. On P/E and P/B we value the stock at INR624 and INR540. Our target price of INR570 is a weighted average where the EPM is assigned a weight of 50% and the PE and P/B derived forecasts are assigned weights of 25% each.

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

Key risks to our valuation include: 1) loan growth could be higher than our estimates; 2) provision for loan loss could be lower; 3) monetary policy might ease the operating environment for banks.

Key financials INRm FY 2009e FY 2010e

NII

Operating profit

PAT

EPS (INR)

P/E*

BVPS*

P/BV

91.5 113.5

106.8 122.0

45.3 52.0

40.7 46.7

12.3x 10.8x

436.7 459.6

1.2x 1.1x

Note: * = price as at close of 04-Oct-2008 Source: HSBC estimates

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Equity Strategy Asia Pacific Fourth Quarter 2008

SMFG (8316, UW/V)  Negligible loan growth, depressed fee income and lower bond

gains to weaken SMFG's top line this year  At the same time, SME and real estate related credit costs are

likely to rise as the domestic economy slumps  Rating Underweight (V); target price JPY500,000

Japan’s banks face the double problem of a weak top line and rapidly deteriorating domestic corporate credit cycle. Corporate bankruptcies are on the rise, particularly among SMEs and in real estate related sectors. As a result, we expect credit costs to continue rising throughout FY Mar-09. This will impact all Japan’s major banks, but we think SMFG is most vulnerable, given its greater exposure to SMEs and its foray into higher-risk unsecured business loans, under its ‘Business Select Loan’ product. Indeed, SMFG already reported a surge in credit costs in the first quarter. Heading into a cyclical downturn, with the domestic economy worsening and credit costs rising, we maintain our Negative overall view on the Japanese megabanks, with SMFG as our bottom pick.

Valuation and risks HSBC forecasts (47% below guidance and 44% below median consensus) imply SMFG is trading at 21.0x FY Mar-09 EPS and 18.3x FY Mar-10. This is too high for a bank moving into a cyclical downturn of unknown length and severity. Our DCF-derived target price of JPY500,000 indicates a more realistic PE of 16.7x this year and 14.6x next.

Brett Hemsley* Analyst HSBC Securities (Japan) Ltd. +81 3 5203 3627 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Risks include better-than-expected performance this year, in particular in terms of credit costs, and/or an improving outlook in the domestic/global economy.

Key financials & valuation Share price: (JPY) 627,000

Market cap: (JPYtrn) 6.5

Year to

Pre-Provision Operating Profit (JPY bn)

HSBC net profit (JPY bn)

HSBC EPS (JPY)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB** (x)

Mar-09e Mar-10e Mar-11e

1,013.0 1,024.4 1,085.6

253.0 287.6 354.1

29,867 34,170 42,445

-47.6 14.4 24.2

21.0 18.3 14.8

2.71 3.51 4.31

4.8 5.3 6.4

1.4 1.4 1.3

Notes: price at close of 3 Oct, 2008. * = Based on HSBC EPS (fully diluted). ** = BPS adjusted for pref stocks. Source: HSBC

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Equity Strategy Asia Pacific Fourth Quarter 2008

Tokyo Electron (8035, U/V)  SPE order recovery delay may drop sales 40%  LCD orders still strong, but this is working through backlog –

weakness to follow. Solar unlikely to plug the gap  Trading on 24x forward EPS appears too expensive.

Rating Underweight (V); target price JPY4,740

With most, if not all, DRAM and NAND flash memory makers now in the red, and foundry capacity utilization falling, a sustained recovery in SPE orders may have to wait until the second half of FY Mar-10, in our estimation. As a result, we expect Tokyo Electron (TEL)’s SPE sales to drop about 40% in FY Mar-09 and recover by only 5% in FY Mar-10. LCD equipment sales should be up nearly 50% this year as the company works off its backlog, but orders have dried up and sales are likely to give up most of that gain in FY Mar-10. However, solar equipment should make up the difference, in our estimation, but total sales are still likely to rise only 6-7% in FY Mar-10 after a drop of about 30% this year.

Valuation and risks The collapse of profit margins this year, combined with a limited recovery next year, leaves valuations extended, in our opinion. Our JPY237.5 EPS estimate for FY Mar-10 puts the shares on a prospective PE multiple of 24x. In comparison, our share price target for TEL and other mainstream SPE vendors is 20x next fiscal year’s earnings. These targets are based on the companies’ historical valuation ranges, industry comparables and market multiples.

Scott Foster* Analyst HSBC Securities (Japan) Ltd 813 5203 3821 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Potential negative catalysts for our Underweight (V) rating include capital spending cuts by NAND flash memory and LCD makers, price competition and a stronger yen.

Key financials & valuation Share price: (JPY) 4390.00 Year to 2007 2008e 2009e 2010e

Market cap: (JPYbn) 793

Net sales (JPYb)

HSBC EBIT (JPYb)

HSBC net profit (JPYb)

HSBC EPS

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

906 638 681 755

168 50 68 100

106 32 43 62

593.92 176.04 237.52 343.71

26.94 -70.36 34.92 44.71

7.4 24.9 18.5 12.8

2.8 0.9 1.0 1.0

19.8 5.7 7.2 9.6

1.5 1.4 1.3 1.2

Notes: Price at close of 3 Oct 2008 * = Based on HSBC EPS (fully diluted) Source: HSBC

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SKT (017670, UW/V)  Sector emerging out of high cost phase but SKT faces challenges  ARPU decline and dual-n/w running costs to curb RoE rebound.

Potential value-destructive investments to aid WiBro negative  Rating Underweight; target price KRW173,000

SKT’s stock has been caught in a 2-year forward PE band of 8-10x for the better part of the past six years. The stock remains underappreciated and undervalued despite healthy FCF generation and an attractive FCFE 09e yield of 13% (at share price of KRW210,000). The primary reason for undervaluation is its value-destructive investment strategy, in our view. The company continues to destroy FCF by pursuing an investment strategy to support home-grown technologies like CDMA and, lately, WiBro at the expense of shareholders.

reduced churn and marketing costs as lock-in contract penetration increases. However, investors must remember that SKT lags behind in 3G migration and, consequently, both the upgrade (2G-to-3G) as well as dual-network (CDMA and HSDPA) running costs limit mid-term RoE expansion. Moreover, SKT’s ARPU, in both voice and data, is likely to decline as bundling and onnet discounts are not offset by positive elasticity. This would also limit RoE expansion.

With WiBro deployments in the US around the corner, we believe the probability of another

SKT is our least preferred stock in the Korean wireless space due to weaker RoE expansion versus peers and concerns on potential investments. Thus, we value it at the bottom of its long-term trading range of 8x FY09e EPS. The key risks to our view are a change in investment strategy, lower/higher than expected marketing costs and less/more than expected ARPU decline.

value-destructive investment is high (see our flashnote Reiterate UW: Negative on potential investments in Sprint published on 18 July 2008). Such an investment would be the key negative catalyst for the stock, in our view. Admittedly, SKT’s RoE is likely to benefit from

Shishir Singh* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4292 [email protected]

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

Valuation and risks

Key financials & valuation Share price: (KRW) 210,000 Year to 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (KRWb) 15,442

Net sales (KRWb)

HSBC EBIT (KRWb)

HSBC net profit (KRWb)

HSBC EPS (KRW)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

11,286 11,557 11,435 11,442

2,172 1,921 2,387 2,948

1,307 1,196 1,569 1,998

17887.52 16485.83 21627.11 27546.75

-20.5 -7.8 31.2 27.4

11.7 12.7 9.7 7.6

4.5 4.5 5.5 7.0

12.6 10.5 13.5 15.8

1.3 1.4 1.3 1.1

Notes: price at close of 29 Sep 2008 * = Based on HSBC EPS (fully diluted) Source: HSBC

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Chi Mei (3009, UW/V)  LCD downcycle only midway through  Bad timing for capacity addition; higher gearing also a concern  Rating Underweight (V); target price TWD18

Current LCD downcycle likely to continue until channel inventory returns to normal. We believe aggressive inventory build since 2Q07 has resulted in 4-5 weeks of excess inventory in the food chain. We estimate it could take another six months for inventories to normalise and believe oversupply of LCD panels will last until 2Q09, despite panel makers cutting capacity utilisation Bad timing of capacity addition. The lead-time for LCD expansion is about 18-24 months, thus all the new capacity add in the next 12 months is pretty well set. We estimate CMO’s TFT-LCD capacity will increase by 36% in the coming 12 months vs. that of LGD’s (034220 KS, N(V)) 22% and AUO’s (2409 TT, N(V)) 5%. CMO should try to slow down the capacity ramp-up process. It is still under greater operational pressure than rivals, especially since almost all panel makers are losing money at the current price level.

14% and 5% from 76% and 49% in the past year. However, CMO’s gearing stood at 60% at end2Q08. With margin under pressure due to falling prices, CMO’s high gearing will be an overhang to its share prices.

Frank Su* Analyst HSBC Securities (Taiwan) Corporation Limited +8862 8725 6025 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to NYSE and/ or NASD regulations

Valuation and risk We reiterate our Underweight (V) rating on the stock with a target price of TWD18 based on the stock’s trough P/B valuation of 0.6x since 2002. The key upside risk is an unexpected reversal of the LCD cycle and panel prices.

Higher gearing also a concern. CMO’s main rivals, AUO and LGD, have seen gearing drop to

Key financials & valuation Share price: (TWD) 20.40 Year to Dec 12/2007a 12/2008e 12/2009e 12/2010e

Market cap: (TWDm) 149,050

Net sales (TWDm)

HSBC EBIT (TWDm)

HSBC net profit (TWDm)

HSBC EPS (TWD)

EPS growth (%)

PE* (x)

Dividend yield (%)

ROE (%)

PB (x)

302,473 316,691 262,064 316,481

44,236 23,298 (3,543) 18,376

36,171 17,020 (8,130) 11,457

5.22 2.30 (1.10) 1.55

n/m -55.84% n/m n/m

3.91 8.85 n/m 13.15

6.94 3.2 0.00 -2.15

17.58 7.51 -3.64 5.15

0.63 0.66 0.70 0.66

Notes: price at close of 06 Oct 2008.

Net sales, EBIT, and net profit in TWD....Source: HSBC estimates

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Disclosure appendix Analyst certification The following analyst(s), who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Akane Nishizaki, Jacqueline Tse, Vivek Misra, Garry Evans, Steven Sun, Leo Li, Gary Chiu, Steven Li, Steve Man, Michelle Kwok, Mark Webb, Rajiv Sharma, Sumeet Agrawal, Neale Anderson, Sean Yang, Eric Lin, Todd Dunivant, Shishir Singh, Frank Su, Brett Hemsley and Scott Foster

Important disclosures Stock ratings and basis for financial analysis

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below. This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website. HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities Stock ratings

HSBC assigns ratings to its stocks in this sector on the following basis: For each stock we set a required rate of return calculated from the risk free rate for that stock's domestic, or as appropriate, regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral. Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.

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Equity Strategy Asia Pacific Fourth Quarter 2008

*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change. Prior to this, from 7 June 2005 HSBC applied a ratings structure which ranked the stocks according to their notional target price vs current market price and then categorised (approximately) the top 40% as Overweight, the next 40% as Neutral and the last 20% as Underweight. The performance horizon is 2 years. The notional target price was defined as the mid-point of the analysts' valuation for a stock. From 15 November 2004 to 7 June 2005, HSBC carried no ratings and concentrated on long-term thematic reports which identified themes and trends in industries, but did not make a conclusion as to the investment action that potential investors should take. Prior to 15 November 2004, HSBC's ratings system was based upon a two-stage recommendation structure: a combination of the analysts' view on the stock relative to its sector and the sector call relative to the market, together giving a view on the stock relative to the market. The sector call was the responsibility of the strategy team, set in co-operation with the analysts. For other companies, HSBC showed a recommendation relative to the market. The performance horizon was 6-12 months. The target price was the level the stock should have traded at if the market accepted the analysts' view of the stock.

Rating distribution for long-term investment opportunities As of 06 October 2008, the distribution of all ratings published is as follows: Overweight (Buy) 51% (19% of these provided with Investment Banking Services) Neutral (Hold)

34%

(18% of these provided with Investment Banking Services)

Underweight (Sell)

15%

(7% of these provided with Investment Banking Services)

Information regarding company share price performance and history of HSBC ratings and price targets in respect of its longterm investment opportunities for the companies the subject of this report,is available from www.hsbcnet.com/research.

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HSBC & Analyst disclosures Disclosure checklist Company BHARTI AIRTEL CHI MEI CHINA EASTERN AIRLINES CHINA RESOURCES POWER ICICI BANK LARSEN & TOUBRO PETROCHINA SHANGHAI ELECTRIC GROUP SINGAPORE AIRLINES SK TELECOM SWIRE PACIFIC THE LINK REIT TOKYO ELECTRON, LTD.

Ticker

Recent price

Price Date

Disclosure

BRTI.NS 3009.TW 0670.HK 0836.HK ICBK.NS LART.BO 0857.HK 2727.HK SIAL.SI 017670.KS 0019.HK 0823.HK 8035.T

756.30 21.60 1.43 15.70 504.35 1159.00 7.71 2.42 14.14 218500.00 63.10 15.60 4390.00

03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008 03-Oct-2008

6, 7 2, 5, 6, 7 2, 4, 5, 6, 7 4 2, 6, 7, 11 2, 5, 6, 7 4, 5, 11 4, 11 5, 6, 7 11 2, 4, 6, 7, 11 5 6

Source: HSBC

1 2 3 4 5 6 7 8 9 10 11

HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months. HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. As of 31 August 2008 HSBC beneficially owned 1% or more of a class of common equity securities of this company. As of 31 August 2008, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. As of 31 August 2008, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking-securities related services. As of 31 August 2008, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. A covering analyst/s has received compensation from this company in the past 12 months. A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company.

Analysts are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company, please see the most recently published report on that company available at www.hsbcnet.com/research. * HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures 1 2 3

4 5

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This report is dated as at 08 October 2008. All market data included in this report are dated as at close 03 October 2008, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Chinese Wall procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. As of 31 August 2008, HSBC beneficially owned 2% or more of a class of common equity securities of the following company(ies) : PETROCHINA, SK TELECOM At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company: China Shenhua Energy

Equity Strategy Asia Pacific Fourth Quarter 2008

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Disclaimer * Legal entities as at 22 August 2007 Issuer of report 'UAE' HSBC Bank Middle East Limited, Dubai; 'HK' The Hongkong and Shanghai Banking The Hongkong and Shanghai Corporation Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' Banking Corporation Limited HSBC Securities (Canada) Inc, Toronto; HSBC Bank, Paris branch; HSBC France; 'DE' HSBC Level 19, 1 Queen’s Road Central Trinkaus & Burkhardt AG, Dusseldorf; 000 HSBC Bank (RR), Moscow; 'IN' HSBC Securities Hong Kong SAR and Capital Markets (India) Private Limited, Mumbai; 'JP' HSBC Securities (Japan) Limited, Telephone: +852 2843 9111 Tokyo; 'EG' HSBC Securities Egypt S.A.E., Cairo; 'CN' HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Corporation Limited, Telex: 75100 CAPEL HX Singapore branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Fax: +852 2596 0200 Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; 'GR' HSBC Pantelakis Website: www.research.hsbc.com Securities S.A., Athens; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv, 'US' HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler A.S., Istanbul; HSBC México, S.A., Institución de Banca Múltiple, Grupo Financiero HSBC, HSBC Bank Brasil S.A. Banco Múltiplo. This document has been issued by The Hongkong and Shanghai Banking Corporation Limited (“HSBC”) in the conduct of its Hong Kong regulated business for the information of its institutional and professional customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited is regulated by the Securities and Futures Commission. All enquires by recipients in Hong Kong must be directed to your HSBC contact in Hong Kong. If it is received by a customer of an affiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. HSBC has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; HSBC makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of the Research Division of HSBC only and are subject to change without notice. HSBC and its affiliates and/or their officers, directors and employees may have positions in any securities mentioned in this document (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). HSBC and its affiliates may act as market maker or have assumed an underwriting commitment in the securities of companies discussed in this document (or in related investments), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those companies. HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the United States and not with its non-US foreign affiliate, the issuer of this report. In the UK this report may only be distributed to persons of a kind described in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001. The protections afforded by the UK regulatory regime are available only to those dealing with a representative of HSBC Bank plc in the UK. 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It makes no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. In Japan, this publication has been distributed by HSBC Securities (Japan) Limited. It may not be further distributed in whole or in part for any purpose. © Copyright. The Hongkong and Shanghai Banking Corporation Limited 2008, ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of The Hongkong and Shanghai Banking Corporation Limited. MICA (P) 258/09/2008

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Macro Equity Strategy Q4 2008

Main contributors Garry Evans* Pan-Asian Equity Strategist +852 2996 6916 [email protected] 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.

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.

Next problem: growth

Steven Y. Sun, CFA* CFA Regional Equity Strategist +852 2822 4298 [email protected]

Akane Nishizaki* Strategist +813 5203 3943 [email protected]

Next problem: growth It will start to wilt

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.

Vivek Ranjan Misra* Equity Strategist HSBC Bank Plc +91 80300 13699 [email protected] Vivek joined HSBC in May 2005 and works for the equity strategy team. Previously, he worked in the manufacturing sector and as an M&A analyst in the oil and gas sector. Vivek is a chemical engineer from Indian Institute of Technology (IIT) and has an MBA from the University of Rochester.

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.

Equity Strategy

Jacqueline Tse* Strategist +852 2996 6602 [email protected]

Leo Li* Strategy Associate +852 2996 6919 [email protected] 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.

Risk aversion won’t ease quickly, but it is unlikely to get much worse. The focus now will shift from rising risk to falling growth. As global growth slows, so will Asian exports, GDP growth and earnings. With valuations perhaps 15-20% above rock-bottom levels, Asian stock markets are likely to fall for another quarter or two. We stay defensive, and favour markets such as China and Singapore, which should have limited downside risk but also the chance of a good bounce when the bottom is reached.

Devendra Joshi* Associate Bangalore

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

By Garry Evans

Q4 2008

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