By FN Arena

With Asian markets being among the hardest hit in the current global correction in equity prices, it is fair to ask whether the scale of the falls in the region are justified based on the outlook for economic growth and corporate profits in the region.

HSBC notes the current correction has been characterised by a divergence between the economic and market data, as the scope of the correction suggests weaker economic growth is likely going forward but the actual growth data suggest continuing solid performance.

The bank points out growth in the March quarter was in fact stronger than expected in much of Asia and particularly so in Hong Kong, India, Korea and Singapore, leading to growth forecasts for 2006 being revised up for most countries in the Asia ex-Japan region.

This has not flowed through into the bank's forecasts for 2007 though, its estimates for next year being largely unchanged. The major reason for this is its expectation growth over the remainder of this year will begin to slow, reflecting a slowdown in the US economy thanks to higher interest rates and the impact of this on the housing market and consumption. Any fall in domestic consumption in the US would be expected to flow through into reduced exports for Asian nations, hence slowing their rate of growth.

Additionally, HSBC points to a continuation of inflationary pressures thanks to ongoing high oil prices as a reason why growth should come down, particularly as the emergence of higher inflation will impact on monetary policy. The implication for Asia in its view is monetary policy remains loose across the region, so to counter inflation further interest rate increases can be expected.

Japan is likely to make such a move in the next couple of months, while the bank also expects the Chinese to continue to tighten policy as attempts to date to slow the rate of growth in capital investment have proven insufficient.

Assuming the bank is right in anticipating a slowdown in exports, the question becomes which countries in the region are best placed to sustain growth thanks to strong domestic demand. Its analysis suggests Hong Kong, India, Korea and Malaysia are the most likely to do so, as domestic demand appears strongest in these countries whereas other economies in the region remain more reliant on exports.

This export question could become even more significant if the US slows significantly, as such an outcome could potentially result in interest rates moving lower in the US at the same time as they move higher in Asia, which would be another negative to sustained growth in the region.

The bank's growth forecasts suggest any slowdown will be marginal rather than significant, as it expects global growth of 4.6% this year and 3.8% next year, while for Asia ex-Japan it is forecasting 7.9% this year and 7.1% in 2007. Within the region, China is forecast to grow its economy 9.4% this year and 8.5% next year, while "other Asia" growth is estimated at 5.2% and 4.7% respectively.

With solid growth still likely, it is possible to argue the recent correction in Asian markets has been overdone. As the bank notes, despite recent downward revisions EPS growth in Asia this year should still be around 11%, putting the market on a forward P/E of about 11.5%. This is 8% below the five-year mean for the region.

Some of this represents a return to more realistic levels, with India providing a good example. The correction in its market has brought back the forward price earnings (P/E) ratio for the Indian market to about 13.8x, which compares to about 21x in early May. Currently India, Korea and Indonesia remain on forward P/Es higher than their five-year means.

While regionally the markets don't appear expensive, the bank notes identifying value remains somewhat difficult given earnings growth estimates in some cases are either too high or too low. For example, it notes Hong Kong and Korea earnings growth estimates currently appear overly pessimistic, while those in Taiwan are too optimistic.

An example is the tech sector, where the forecast is for 76% growth in earnings in Taiwan, compared to just 4% in Korea. As a result, the bank cautions while the Taiwanese market appears cheap compared to historical valuations, the unlikelihood of earnings forecasts being met means this is a deceptive view.

Those looking for strength should focus on the healthcare and consumer staples sectors as they are the only ones to enjoy upward earnings revisions in the region. In contrast, estimates for cyclical sectors such as the techs, consumer discretionary and industrials have recently been revised down by more than 4% each.

Copyright FN Arena/The ASIA Miner