Still a bright spot; reform to sustain growth
China’s growth prospects still look promising, but we believe further
financial reform, deregulation and adjustments to the growth model are
critical to realize that full potential. We expect the HSCEI and CSI300 to
reach 16,800 and 4,300 by end 2010, equating to 26% potential price
returns. We believe macro growth momentum and policy variables are
likely to dictate the path of returns, which couldbe skewed to the first and
fourth quarters and could show high volatility on tightening concerns.  
A fundamentals-led story
A dramatic multiple normalization process is largely completed, and
argue that price returns in 2010 will be mostly earnings-growth drive
We forecast 23%-26% EPS CAGR for Chinese stocks over 2009-2011E
underpinned by sustainable revenue growth, a rapidly closing outpu
gap and gradual margin recovery. Valuations appear attractive for H
and fair for A, while liquidity risks look favorable medium term.
Investment strategies: Alpha overtakes beta
The likely shift in returns dynamics implies a favorable risk/reward fo
engaging in active sector allocation, thematic investment, and pair-
trade opportunities to derive alpha. We remain overweight on sector
exposed to domestic demand and see compelling themes around tw
secular trends in China — Deepening reform and integration.