After an underperforming year vs. EM and a major regulatory reset, we still see lingering risks into 2022 for MSCI China: earnings headwinds, extended tight liquidity, US/China nontrade tensions, and near-term property market volatility.

Prefer A-shares to offshore China.

MSCI China is still at a critical juncture: This follows the worst drawdown relative to EM post-GFC (15ppt underperformance YTD), with historical secular bull trades (i.e., Internet) shifting to a new operational environment.

We remain relatively cautious and stay equal-weight on Chinese equities within the global EM framework: We expect limited relative upside by year-end 2022 (5% for MSCI China vs. 3% for MSCI EM). Our December 2022 base case index targets are 95, 25,000, 9,000 and 5,250 respectively for MSCI China, Hang Seng, HSCEI and CSI300.

We have four market-level concerns: 1) Earnings growth faces headwinds (in our base case we are 4ppt below consensus for 2022): elevated PPI, potential power shortages in winter, COVID resurgence, and further slowdown from the property market and retail consumption.

2) Equity market liquidity will remain relatively tight through 2022. Government easing measures would remain moderate by magnitude – our economics team for China sees marginal countercyclical easing.

3) Property market default concerns remain a key unresolved risk, with the market pricing for incrementally more offshore property bonds going into default and a large-scale redemption schedule coming up in December/January.

4) US/China non-tariff tensions could also escalate, notably on the audit dispute front, with more US action pushing for sooner and stricter delisting protocols.

We see a slight upward skew in the bull-bear spread... Along with China's underperformance YTD, a relatively more independent policy cycle gives policy makers room to step up easing and recalibrate their approach to a regulatory reset. In contrast, broad EM has a largely symmetric bull/bear risk skew.

…but think positives and negatives overall do not justify a major upgrade now: Despite such a record underperforming year, we still see some lingering risks skewed towards higher volatility or more downside in the near term.

We continue to prefer A-shares vs. offshore China: Supportive measures should encourage long-term institutional participation, both domestically (acceleration of personal pension scheme) and internationally (more offshore hedging tools).

CSI 300 trades at a 2% premium vs. MSCI China on 12-month forward P/E, suggesting A-share market valuation is still reasonable.