Morgan Stanley Raises Outlook on China Stocks Amid Improving Earnings and Valuation Prospects

Morgan Stanley has upgraded its year-end targets for key Chinese stock market indexes, citing stronger-than-expected earnings growth and improving valuations.

The Wall Street firm now sees an 8% to 9% upside for major indexes such as the MSCI China Index and the Hang Seng Index. However, analysts warn that US-China tensions and economic headwinds could pose risks to the rally.

According to Morgan Stanley strategists, led by Laura Wang, the primary driver behind the revised outlook is China’s improving corporate earnings environment. Fourth-quarter results from companies in the MSCI China Index showed an 8% net earnings beat, marking the first time in over 13 quarters that earnings have outperformed expectations.

“Aggressive cost-cutting, corporate self-help measures, and increased investment in technology and AI have contributed to this turnaround,” Morgan Stanley stated.

Additionally, the valuation gap between Chinese stocks and other emerging markets has been narrowing. Currently, Chinese stocks are trading at 10.2 times forward earnings estimates, compared to 11.6 times for other emerging markets. The firm believes that as earnings growth continues, Chinese stocks will no longer trade at a discount relative to their peers.

Despite ongoing concerns about potential tariff hikes from the US, Morgan Stanley notes that these risks are somewhat limited. The MSCI China Index has just 3% revenue exposure to the US, the lowest among America’s top 10 emerging market trading partners. Analysts argue that since many tariffs have already been imposed, the potential for further major tariff shocks is relatively low—unless President Donald Trump follows through on threats to raise Chinese tariffs to 60%.

While tariffs are a lesser concern, Morgan Stanley highlights a more significant risk: potential investment restrictions stemming from rising US-China tensions.

In February, President Donald Trump signed the America First Investment Memorandum, which directs US government agencies to explore new restrictions on investments in key Chinese industries, including semiconductors, artificial intelligence, and quantum computing.

While details remain unclear, Morgan Stanley warns that such restrictions could deter US investors from putting money into Chinese markets. In a worst-case scenario, the US could ban major public equity investments in China, leading to a potential low double-digit percentage decline in the MSCI China Index.

However, non-American investors could see this as a buying opportunity, much like in 2021, when restrictions on China Mobile and CNOOC initially hurt stock prices before attracting global investors.

Beyond geopolitical risks, China’s overall economic climate remains uncertain. Morgan Stanley’s economic team forecasts 3.6% nominal GDP growth and 0.9% inflation for 2024, suggesting a sluggish recovery.

At the same time, Chinese stocks have gained momentum this year, with the MSCI China Index up 16%—outpacing global markets. Investor optimism has been fueled by advancements in AI, Beijing’s economic stimulus measures, and a more positive tone toward tech companies from President Xi Jinping.

Following Morgan Stanley’s upgraded forecast, Chinese stocks continued their upward trend. The firm recommends overweighting A-shares within a Chinese portfolio and suggests buying high-quality stocks on market dips for non-US investors.

Meanwhile, Goldman Sachs has echoed Morgan Stanley’s optimism, stating that China remains on investors’ radar with room for further growth. However, they caution that geopolitical tensions and upcoming US-China policy decisions could slow the rally.

With earnings finally beating expectations and valuations improving, Morgan Stanley sees strong potential for Chinese stocks in 2024—but investors will need to navigate geopolitical uncertainties carefully.

With input from Bloomberg, Reuters, and Market Watch.