TheChek News Flow

We raise offshore Chinese equities (MSCI China) to Overweight from Market-weight in a regional context to reflect our expectation that the tactical trading backdrop for China has improved, underpinned by: 1) a potential cyclical pickup in investment provoked by renewed policy easing: 2) a stabilization in corporate earnings growth/profitability; 3) an equity-friendly liquidity environment buttressed by a dovish Fed (EM flows), and entrenched market expectation for further Rmb weakness and onshore yield-chasing flows (Southbound); and, 4) light investor positioning, China’s relative appeal as an inexpensive laggard vs. APJ and EM, and forthcoming catalyst (SZ Connect). Our refreshed 12m index target for MXCN is 70 (from 60.5), implying 9% upside. MXCN has gained 6% since we downgraded it to MW on Dec 3 2015, moderately underperforming APJ and EM by 5pp and 8pp respectively.

While China’s tactical return case has brightened, we recognize that the structural imbalances in the system remain significant, MXCN has bounced 35% from its lows in Feb (17% since the Brexit vote), investor sentiment is about 1.5 s.d higher than the past 120d averages, and the near-term Fed policy outlook is far from certain, all pointing to the need for selectivity and strong emphasis on risk/reward in our view.

1. Heavy index weights to position for continued passive EM 1. inflows. Within the space, we remain positive on Tech/ADRs (New China) which have contributed 80% of MXCN’s ytd returns but are still underweight by EM funds (~240bps);

2. High-yielding stocks in the Southbound universe to meet onshore yieldchasing demand. Besides, HK/China financials (banks), China Utilities, Macau, and HK/China property also offer high yields.

3. Select domestic infra-spending proxies with high sensitivity to infra FAI growth.