The Ox is slow
This Year of the Ox suggests traits that investors are looking for right
now: strength and reliability. Unfortunately, the ox is also slow - and
that’s what we expect for any recovery. In the US, the S&P is down to
almost single-digit trailing PE, and if Obama’s policies fail, long-term
measures point to even further downside. By contrast, we’re confident in
Beijing’s ability to reflate the economy. We believe that China equities will
continue to outperform and valuations are cheap.
China can trade at a premium to the US
􀂉 China has been and is likely to continue to outperform the S&P500. Our top
absolute performance idea is to long the China market and short SPX.
􀂉 The China MSCI is trading at 9x trailing PE, or almost par with the S&P500, which
is at 10x PE. We believe China MSCI can sustain higher valuation than the S&P.
􀂉 Market correlation remains high, with the MSCI China at close to 90% R-square
with the S&P500.
Little joy in long-term measures
􀂉 A lesson from the credit crisis is the need to view markets on much longer cycles.
􀂉 Our estimates of cyclical PE for China and the US, based on average real long-term
earnings, are at a 25% discount to long-term averages (similar to the Q Ratio).
􀂉 Valuations are above previous bottoms, which make the market vulnerable to a US
policy blunder. China’s GDP is only one-third of the US and can’t rescue the world.
􀂉 Our target for the MSCI China is 42 and for MSCI Hong Kong 6,700.
Don’t underestimate China
􀂉 The 8% GDP growth number is a political signal to align local, regional and central
government policies. GDP will likely come in higher than bears expect.
􀂉 We are confident of the government’s ability to reflate the economy and are
impressed with the size of the stimulus plan and speed of execution.
􀂉 We believe there will be a “Stimulus II” or “Harmonious Society II” plan which
addresses the need for long-term structural change to drive consumption.
This cycle is different
􀂉 China’s is the typical cyclical problem of excess capacity, but the excess is on a
global scale that will take years to bring into balance.
􀂉 Our investment focus is to Overweight industries that have avoided excess and
focus on consumers who are the ultimate beneficiaries of government stimulus.
􀂉 Our China portfolio, with 20 stocks highlighting our best ideas from 6 February this
year, is down 4% since then, but has outperformed the MSCI China by 5%.

Contents
Executive summary ............................................................................ 3
China can trade at premium to the US................................................ 4
Little joy in long-term measures ...................................................... 12
Don’t underestimate China............................................................... 21
This cycle is different ....................................................................... 30