China shares have enjoyed a three-month-long rally and now it's time for investors to turn selective, analysts said.
Since the beginning of July, the Shanghai Composite has tacked on more than 11 percent, while Hong Kong's Hang Seng Index has gained around 12 percent, even as many regional markets suffered a bout of extreme volatility amid concerns the U.S. Federal Reserve would begin to taper its asset purchases. Indonesian shares, for example, have fallen around 6.5 percent over the same period.
"Market return is more likely to be muted or show slight downside near term unless we see positive surprises from reforms and very robust external demand. We expect looming profit-taking pressure ahead of some major events like the third plenary session, local government debt audit results, and a potential slowdown of October macro data," Goldman Sachs said in a note.
China's Communist Party leaders will hold the third plenary session in November to set the country's economic agenda.
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But Goldman added, "We still see some favorable factors that may support China equities."
It advises playing sectors where earnings and sentiment could be boosted by further policy progress, such as healthcare, brokerages, the railroad-related value chain and possibly banks, if there are signs of gradual interest rate deregulation and significant fiscal reform targets. Many of the stocks in these sectors are trading at reasonable valuations compared with historical levels, it noted.
(Read more: Emerging markets poised for further rally: BofA-ML)