Morgan Stanley, Goldman Sachs Bullish on China's 8% Earnings Surprise

Morgan Stanley and Goldman Sachs have both expressed optimism about the Chinese market, with Morgan Stanley raising its target price predictions for several key Chinese indices and Goldman Sachs noting increased global investor interest in China. Morgan Stanley's adjustments were driven by improved earnings growth expectations and a re-evaluation of valuation levels. The firm highlighted that the MSCI China Index's earnings performance for the fourth quarter of 2024 exceeded expectations by approximately 8 percentage points, marking the first time in three and a half years that the index has surpassed forecasts. This performance placed China second only to Japan in terms of earnings surprises among global stock markets.

Morgan Stanley also noted that the MSCI China Index's net asset yield recovery and easing geopolitical risks have driven an initial round of valuation re-evaluation since the beginning of the year. The 12-month forward price-to-earnings ratio for the MSCI China Index has increased from 10.2 times to 11.6 times. The discount of the MSCI China Index relative to the MSCI Emerging Markets Index has narrowed to 6%, and Morgan Stanley expects this discount to eventually disappear. The firm attributed this to the healthy earnings performance and upward revision trajectory of the MSCI China Index, which is superior to that of the MSCI Emerging Markets Index. Additionally, companies in the MSCI China Index are in a relatively advantageous position in dealing with U.S. tariffs, with only 3% of their revenue coming from the United States, the lowest proportion among the top ten emerging market trading partners of the U.S.

In the short term, Morgan Stanley recommended over-weighting A-shares in Chinese investment portfolios. The firm suggested that the net asset yield, earnings surprises, and fixed asset investment data all point towards continued over-weighting in sectors related to technology and artificial intelligence research and application.

Goldman Sachs, on the other hand, released a report indicating that global investors' interest in the Chinese market has been increasing. Despite a 20% rise in Chinese stocks since the beginning of the year, Goldman Sachs noted that further upward revisions in corporate earnings expectations are still possible. While short-term factors such as profit-taking by investors may slow down the bull market, the firm believes that the strong fundamental support behind this market rally suggests that the upward trend could be sustained over the long term.

Goldman Sachs conducted extensive discussions with investors in various regions, including mainland China, Singapore, the United States, and Europe, following the Lunar New Year holiday. The firm found that investor interest and participation in Chinese stocks have reached a four-year high. Goldman Sachs identified several reasons for the renewed interest in China, including the unexpected strong performance of Chinese stocks, the emergence of DeepSeek, which has changed the narrative around China's technology sector, and the government's encouragement of the private sector as signaled by the private sector economic conference. Additionally, global investors are seeking alternatives to the U.S. stock market, and China's stock market is seen as a potential option due to its liquidity, valuation, and diversification benefits.

Goldman Sachs also noted that global funds are showing interest in returning to China. Data from Goldman Sachs' prime brokerage services indicated that global hedge funds have increased their net and total exposure to Chinese stocks. Southbound funds flowing into the Hong Kong market have reached a record high this year. Publicly offered funds have also increased their allocations to China, with a focus on emerging markets and Asia. However, participation from investors targeting the global market remains relatively low.

Investors targeting the global market have shown a strong interest in increasing their holdings of Chinese stocks. This is due to high policy and trade uncertainties in the U.S., with institutional holdings of U.S. stocks near historical highs. The recent adjustment in the U.S. stock market has demonstrated China's ability to provide diversified returns for global investors. From a global perspective, China's valuations are attractive.