Investors should exercise caution while chasing Chinese stocks, among the best performers globally last month, amid technical signs the market is in overbought territory and global fund managers have already boosted their holdings, according to Morgan Stanley.
The gains in Chinese stocks will probably wane, and investors should approach with care at the current level, analysts led by Laura Wang at the US investment bank said in a report on Tuesday.
There was less urgency for overseas traders to rotate out of US and Japanese stocks now, with headwinds from geopolitical risks, rising bond yields and foreign-exchange markets subsiding, it said.
“We see near-term technical overbought signals, which could deter further buying by global quant funds,” Morgan Stanley analysts said. “Consumption and the housing market likely need more time to pick up, implying ongoing pressure on deflation and corporate earnings.”
The call may dampen Chinese and Hong Kong stocks, which are back in favour with foreign investors amid depressed valuations and rebalancing of global portfolios. The Hang Seng Index surged 7.4 per cent in April, the best performer among major stock gauges globally, while the CSI300 Index of yuan-traded stocks gained about 2 per cent, buoyed by a third consecutive month of foreign inflows.
The 14-day relative strength index of the Hang Seng Index remained above 70 for four days up to Tuesday, a level indicating stocks are technically overbought and due for a pullback . The benchmark fell nearly 1 per cent on Wednesday, extending a 0.5 per cent decline the previous day.
Morgan Stanley’s warning comes at a time when global investment banks from UBS to Goldman Sachs and BNP Paribas have turned positive on Chinese stocks. UBS lifted its recommendation to overweight and Goldman sees up to a 40 per cent gain due to market reforms, while BNP raised the target for the MSCI China Index by 4 per cent, citing the pro-growth tone at a Politburo meeting last month that called for more policy support for the troubled property market.
Corporate earnings now hold the key to whether the rebound can hold up, according to Morgan Stanley. The number of mainland-listed companies falling short of earnings estimates dropped to 27 per cent in the first quarter from 38 per cent in the previous three-month period. But this could be an aberration amid a downtrend that is still accelerating, which could stymie re-rating opportunities, the bank said.
“China’s rally needs domestic fundamentals – in particular earnings – to improve for the recent rally to be sustained,” Morgan Stanley said.