Morgan Stanley has upgraded China to overweight from equal-weight, given the relaxation in Covid restrictions, stabilisation in property markets, the regulatory reset wrapping-up as well as early signs of the US and China intensifying bilateral communications at both the state and business levels.
Indian equities have been a beneficiary of overseas investors pulling out money from China. This may change if the latter gains favour among investors again. The Nifty 50 is up 7.7% this year while the MSCI EM index is down 25%. Hang Seng and the Shanghai Composite are down 16% and 11.6%, respectively.
The brokerage has reiterated its overweight call on emerging market equities versus those of developed markets. The US dollar peaking and the US Fed rate hike cycle coming to an end around year-end 2022 or the start of 2023 imply positive earnings impact and easier liquidity environment. This augurs well for emerging markets broadly as well as for China.
This is the first time since February 2021 that the brokerage has been overweight on China versus the MSCI EM. The MSCI China has underperformed the MSCI EM by 980 basis points year to date and by 230 basis points since early October.
“EM bull cycles often start in US recessions, and this may again prove to be the case. But, a deep downturn throughout 2023 would take longer to digest. China’s transition from Covid-zero to mitigation is also likely to be bumpy in terms of growth and earnings recovery,” the brokerage said in a note.
Morgan Stanley has made a parallel increase in its bear, base, and bull target
P/E multiples of +0.5x for MSCI EM and MSCI APxJ, with its new base case EM multiple standing at 11.5x. Its earnings forecasts move up about 5%, given a rapid retracement of the US dollar. As a result, its MSCI EM target has moved to 1,100 from 1,000 (implying 12% upside from last Thursday’s close), while its AxJ target moves to 590 from 510 (14% upside).
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The brokerage’s global macro team forecasts that the US Fed rate hike cycle will stop with the last hike of 25 bps taking place in January 2023. The team also expects the US 10-year government bond yield to decline to 3.5% by year-end 2023.
