Chinese stocks mired in secular bear market, says Morgan Stanley chief strategist

Hong Kong and China stocks, both onshore and offshore, may be in a secular bear market phase, he said in an interview. At least for now, this market is not as attractive as other markets.

THE MSCI China Indexwhich tracks more than 600 representative Chinese companies listed in China and overseas, has fallen 55% from its record high in February 2021. There have been several counter-trend rebounds, Garner said, including the six-month rebound game reopening from October 2022 and the a policy fueled by an upward trend from April of this year. None of these trends have proven to be sustainable uptrends.

The reason we are in a bear market situation is very simple, he explained. Underlying economic growth is quite weak and, as a result, corporate earnings growth is weak, particularly for U.S. dollar investors.

Uneven economic recovery after years of strict Covid controls, coupled with long-running health crisis real estate slowdown Political uncertainties and weak markets have undermined domestic investor confidence. At the same time, poor results and growing geopolitical tensions are discouraging global funds, which have reduced their exposure to China at a level close to a historically low level.

However, most efforts appear to have failed. Shanghai Composite Index Last week, the dollar slipped again below the psychological floor of 3,000 points, erasing all its progress this year, while the CSI 300 index that tracks the country's largest companies barely managed to generate a positive return.

For the market to improve, consumer sectors, including e-commerce, need to generate better underlying revenue growth, Garner said. For now, we're pretty cautious about that.

For those looking for a silver lining in cheap valuations, which are now about 10% off their lowest level in a decade, it is important to note that profitability is facing a structural decline, he said. Return on equity for Chinese companies in the middle of the last decade was about 17%, about the same level as India today, but it has fallen to about 10% and continues to decline.

“With changes in the economy and business models, we see that corporate margins are shrinking significantly and asset utilization is trending down,” he said.

Since joining Morgan Stanley’s Asia Research division in 2006, which has topped the Institutional Investors rankings for seven consecutive years, Garner has often been a lone voice. In one of the most recent calls, on May 9, he warned against chasing Chinese rally amid wave of buy cheers of Goldman Sachs and UBS. The race has since cratered after peaking later in the month.

China's prolonged slump has also led to a significant reduction in its weighting in the MSCI Emerging Markets Index, from around 45% to around 25%, with other large emerging markets such as India and Taiwan filling the void.

Japan and India, the new darlings of investors turning away from China, are both in secular bull markets and could continue to be attractive destinations for capital, Garner said. Both are posting very strong earnings growth of 15% to 20% year-over-year, and domestic investors in both markets are very engaged and buying stocks.

The Topix index, which surpassed its 1989 peak and hit a record high last week, could hit 3,200 points by next June, up about 11% from its current level, Garner said. India's Sensex is also expected to outperform the Shanghai Composite Index for the fourth consecutive year, he said.

According to Garner, investor attention is now much broader in Asia than before. Asian investors are focusing on a broader range of opportunities than they were three years ago.

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