So this is how bulls put their feet up. A month ago, Morgan Stanley - a true believer in emerging markets - said it was reducing its exposure to developing-world stocks. Now it’s scaling back on China in particular, after the country’s equities were its worst EM performers during the last month. That’s a sign that the long mid-year party has ended. But, in the aftermath, Morgan Stanley analysts are more likely to reach for champagne than Alka-Seltzer. They can afford a little less risk now, having enjoyed the rally that took the Shanghai Composite up 24 per cent between July and October (see chart below). Morgan Stanley promoted China’s appeal as early as May, suggesting in a report that investors looking “for an asset class that can truly generate independent, non-correlated returns… [should] focus on Chinese equities.”

Yet, while Chinese returns may have withstood global fears, they can’t escape domestic doubts. In Morgan Stanley’s list of countries, China’s business cycle score has fallen from first to thirteenth place - overtaken by Brazil, South Africa and even Hungary. As analyst Qing Wang wrote in a separate report, “the recent flaring in inflation suggests the Goldilocks scenario [not too hot, not too cold] is close to running its course.” He went on to say that if the government adopts administrative controls to cool inflation, “the risk of policy-induced boom (in 2010) and bust (2011) cycle would be on the rise.” Previously, Morgan Stanley had recommended that investors hold 3.25 percentage points more in Chinese stocks than the MSCI average would suggest. In Tuesday’s report, it says the difference should be 1.25 percentage points. That still represents an overweight, partly on the basis that China’s stocks have actually improved against their regional peers in terms of price-to-book and price-to-earnings ratios. (Markets in Indonesia and elsewhere have failed to price in the impact of rising inflation, Morgan Stanley argues.) Indeed, the Shanghai Composite has fallen 10-per-cent since its six-month peak in November, on government measures to stem inflation. That’s the bulk of the 10-15-per-cent decline predicted by HSBC last week - and could provide some bargain opportunities. But with the Chinese authorities known for incremental moves, and with Chinese media clear about the need to tackle inflation, even enthusiastic bulls are wary to charge.