Our index target cuts mostly reflect our reduced 2021 and 2022 earnings growth forecasts, owing to our more cautious GDP growth outlook for China and incremental margin pressure from regulatory reset execution. Stay cautious on Chinese equities. Prefer A-shares to offshore China.

We cut our June 2022 base case index targets for Chinese equities to 90 for MSCI China (-3% versus 14 September 2021 close), 5,100 for the CSI 300 (+4%), 24,400 for the Hang Seng (-4%), and 8,750 for the HSCEI (-4%). This move is mainly driven by reductions in our earnings growth forecasts for 2021 and 2022, as a result of macro headwinds and regulatory reset's impact on margins. We now expect MSCI China's earnings to grow 15% for 2021 and 11% for 2022, down from our previous forecasts of 18% and 14%. We also move our multiple assumptions slightly lower, now targeting 12.5x forward P/E for MSCI China (or 58th percentile of the five-year range) vs. 13.0x previously in view of continued regulatory policy uncertainty. We stay cautious on Chinese equities and continue to prefer A-shares to offshore China.

More cautious GDP growth outlook: Morgan Stanley's economics team for China has reduced its 2021 GDP growth forecast twice, to 8.2% recently, and has just cut its 3Q GDP YoY growth outlook 60bps, to 4.5%. Recurrence of local/regional COVID outbreaks has hindered the recovery of private consumption and services.

August retail sales data were greatly disappointing. The overall tightening policy since November 2020 and elevated PPI level have put pressure on margins and corporate investment, as seen in recent subdued PMI readings.

Regulatory reset implementation, including EIT hike, implying pressure on margins and earnings: As regulatory reset transitions into the implementation phase, we believe the recent developments in cybersecurity, antitrust, and data privacy would curb margins and earnings growth for affected sectors. For example, the upcoming enterprise income tax (EIT) rate hike from 10% to 15% for Internet companies owing to disqualification as Key Software Enterprises could also cause a 1.5ppt reduction of annual EPS growth at the MSCI China index level. Uncertainty remains on how to quantify the broader objectives of regulatory reset in key sectors, and we suspect this is not yet fully discounted in stock prices. This was seen as recently as 14 September in the case of the 15%plus decline in Macau gaming stocks. To reflect that uncertainty, we take our valuation assumptions lower again today.