Morgan Stanley Warns Chinese Stock Rally May Lose Steam

Morgan Stanley predicts that the momentum behind one of the world’s biggest stock rallies in China could be losing steam, advising investors against chasing gains at the index level. In a recent note, strategists from the US bank, led by Laura Wang and Jonathan Garner, recommended focusing on single-stock and thematic opportunities due to improved investor sentiment.

“Global investors’ fund positions have already improved; meanwhile, there is less urgency to diversify away from the US and Japanese markets, given that the geopolitical, yield, and FX factors are abating or reversing,” they noted. They also pointed to near-term technical overbought signals that could dissuade further buying by global quant funds.

The rebound in Chinese equities from multiyear lows has sparked optimism that the market has bottomed, with analysts from Goldman Sachs Group Inc. noting a growing “fear of missing out” among traders. However, the market’s trajectory remains uncertain, with skeptics highlighting weak earnings growth and a deflating property sector as reasons for caution.

On Wednesday, the onshore CSI 300 Index dropped as much as 0.7% after reaching its highest level since October in the previous session. The Hang Seng Index fell for a second consecutive day, following a 10-day winning streak. Despite these declines, Hong Kong’s benchmark indices have rallied over 10% since the end of March, propelled by cheap valuations, improving macroeconomic data, and Beijing’s supportive policies. The Hang Seng Index was among the best performers in April.

Despite the recent rally, Morgan Stanley noted that China’s consumption levels and housing market likely need more time to recover, suggesting ongoing deflation and corporate earnings pressures. They also expect the pace of real estate policy change to remain “rather modest.”

Skeptics are concerned about the sustainability of the rally. Shen Meng, a director at Chanson & Co., questioned whether Beijing’s reforms and opening-up policies would be effective in addressing the property downturn. Union Bancaire Privee suggested the Hang Seng’s recent outperformance might be driven by internal Chinese flows, rather than fundamental strength. Bank of America Securities warned of potential setbacks due to geopolitical tensions, weaker macroeconomic data, and policy disappointment.

Morgan Stanley has maintained its equal-weight rating for Chinese stocks since downgrading them in August 2023, as the market rout deepened. The firm further reduced targets for major Chinese stock benchmarks in January, though the MSCI China Index has rebounded 14% since then.

Looking ahead, Morgan Stanley cited geopolitical uncertainty, including the upcoming US elections and EU trade controversies, as a potential headwind for Chinese equities. Investors are urged to approach the Chinese market with caution, focusing on selective opportunities and remaining aware of broader market risks.