Morgan Stanley Says Take Profits On China, Downgrades Shares

Pedestrians along an elevated walkway as an electronic ticker displays stock figures in Pudong's Lujiazui Financial District in Shanghai, China, on Friday, May 26, 2023. The cost of 12-month interest-rate swaps, which anticipate where interest rates will be in a year’s time, slipped to 2.06% this week, down from as high as 2.47% just over two months ago. Photographer: Qilai Shen/Bloomberg

(Bloomberg) -- Morgan Stanley cut its rating on Chinese stocks to equal weight Wednesday, saying investors should capitalize on a rally spurred by government stimulus pledges to take profits.

Chinese assets have gotten a boost in recent days amid a slew of promises from Beijing to spur growth and revitalize the nation's flagging private sector. But easing measures are likely to come piecemeal, analysts at the bank wrote in a report, which may not be enough for shares to sustain gains.

What's more, market sentiment is refocusing on the country's structural challenges, they said, including local government issues and unemployment, which still lack detailed solutions.

“We take the July politburo meeting as sending more dovish signals given the clearer stance on stabilizing economic growth and supporting the private sector,” analysts including Laura Wang and Fran Chen wrote. “However, we believe that investor confidence and conviction level are still very fragile, and that investors are still reluctant to pre-position in a major way, given that they have been disappointed by rather lackluster/lukewarm easing measures seen since March.”

Other key issues, including the nation's troubled property sector and geopolitical tensions with the US, also need to improve to attract sustainable inflows, they added.

The strategists had turned overweight in Chinese stocks in December amid the nation's reopening, but slashed targets for key equity gauges in June, citing a delayed earnings recovery, weaker currency outlook and geopolitical uncertainties.

China fell to No. 13 from No. 3 in the bank's 28 country developing-nation market allocation framework, relative to the last review.

As for a reentry point, the bank highlighted early October, when another top-level gathering of party officials could spur reforms, and the downside of earnings may be largely priced in.

A “bottoming out of earnings growth and clearer structural outlook, in combination with continuous stabilization of geopolitical conditions, would offer a better upgrade opportunity and attract back long-term money,” the analysts wrote.

Morgan Stanley also downgraded Taiwan to equal weight, noting that valuations are stretched amid a surge in tech stocks.

“While difficult to call a top amid a market driven by the AI-thematic and retail investors, we think a lot has been priced in and move to the sidelines,” the report said.

(Adds chart, strategists' track record)

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