Morgan Stanley has upgraded its stance on offshore Chinese equities, citing a sustainable recovery in return on equity (ROE) and a shift in valuation dynamics. The bank, which had previously been skeptical about the market’s prospects, now sees a more durable rebound driven by corporate self-help measures, improved geopolitical conditions, and renewed government support for private enterprise. As a result, the firm raised its price targets for MSCI China and the Hang Seng Index, upgrading its rating to Equal Weight (EW).
Analysts at Morgan Stanley believe a structural transformation is underway in China’s equity market, particularly offshore, which could support a longer-term recovery in both ROE and valuations. Unlike previous rallies, the recent improvement in MSCI China’s performance appears more sustainable, leading the bank to shift from deep skepticism to cautious optimism.
Despite persistent concerns over deflationary pressures, Morgan Stanley is increasingly confident that the ROE trough for MSCI China is in the past. The bank highlights three key factors supporting the turnaround:
- Corporate self-help and shareholder-friendly actions – Companies have been aggressively managing costs, conducting share buybacks, and increasing leverage where appropriate, particularly among previously under-leveraged firms.
- Diminishing macroeconomic influence – The weight of highly cyclical and macro-sensitive sectors in the offshore China index, such as property and consumer staples, has declined by nine percentage points to just 15% since 2022. This makes offshore Chinese equities less vulnerable to broader economic headwinds.
- Technology sector resilience – Chinese firms are making notable advances in AI and technology, exemplified by developments from companies like DeepSeek. Drawing comparisons to Japan, Morgan Stanley notes that tech-heavy firms can sustain margin and ROE growth even in a deflationary environment, benefiting from China’s strong engineering talent, access to data, and a well-developed digital ecosystem.
MSCI China’s ROE has already climbed from 9% in mid-2023 to 11%, pushing it from the 70th to the 91st percentile within MSCI Emerging Markets (EM). The firm believes this momentum can continue, with ROE potentially exceeding 12% by the end of 2026, surpassing the current EM average of 11.9%.
Morgan Stanley’s shift in tone marks a significant departure from its previous skepticism, underscoring a growing belief that offshore Chinese equities are emerging from a prolonged downturn. While risks remain, the bank sees a more constructive path forward, provided economic conditions do not deteriorate further.