Morgan Stanley picks China stocks to ride out a worst-case scenario in U.S. tensions

After last month’s excitement over stimulus plans, Chinese stocks now face mounting challenges as earnings have yet to pick up and heightened U.S. trade tensions loom. “Stock picking remains important with [the] headwind of tariffs, a weaker currency and persistent deflation,” Morgan Stanley chief China equity strategist Laura Wang and a team said in a report Thursday. For investment options, she referred to the firm’s survey of China stocks the investment bank’s analysts already cover. The firm screened for stocks that could outperform depending on which of three scenarios unfolded. Only the bear case accounted for significant U.S. tariffs and restrictions. The base and bull cases assumed the status quo in U.S.-China relations. The bear case also expects 1 trillion yuan, or $140 billion, in fiscal stimulus a year and MSCI China earnings per share growth of 3% this year and 5% next year. Morgan Stanley’s basket of bear case stocks only includes overweight-rated names with a dividend yield above 4% this year. They also have free cash flow yield above 4% from 2023 to 2025 and market capitalization above $2 billion, among other factors. The companies must not be on Morgan Stanley’s lists of stocks at a disadvantage from Republican policy and supply chain diversification. The only consumer name that made the list was Tingyi , a Hong Kong-listed company that owns instant noodles brand Master Kong. The company is also PepsiCo ‘s exclusive manufacturer and seller in China. Tingyi’s net profit in beverages rose nearly 26% in the first half of 2024 compared to a year ago, while that of instant noodles rose 5.4%. Morgan Stanley expects Tingyi’s earnings per share to grow 12% this year and 11% in 2025. Other Chinese companies that made Morgan Stanley’s bear case basket included two state-owned energy stocks: drilling company China Oilfield Services and Cosco Shipping Energy Transportation , which specializes in shipping oil and natural gas. Both stocks are listed in Hong Kong, as is the only industrials name on the bear case list, Sinotruk . The truck manufacturer is also state owned. Morgan Stanley expects China Oilfield Services can grow earnings per share by 41% this year and 33% next year, while Cosco Shipping Energy Transportation can see its earnings rise 33% this year, before slowing to 16% growth next year. Sinotruk earnings can grow 18% this year and 17% next year, according to Morgan Stanley estimates. MSCI China constituents are on track for their 13th straight quarter of earnings misses, despite recent improvements in economic data, Morgan Stanley’s Wang said. “We expect further earnings downward revisions amid lingering deflationary pressure and geopolitical uncertainties until more policy clarity emerges.” Asia equity fund managers have modestly increased their exposure to China since September’s stimulus announcements, Morningstar strategist Claire Liang said in a phone interview Friday. “But many managers have said whether this rally can continue will depend on whether the policies can see real results,” Liang said in Mandarin, which was translated by CNBC. Beyond stabilizing the economy, she said the managers are looking for whether corporate earnings can recover. China’s October data release on Friday underscored a slow economic recovery despite the latest barrage of stimulus announcements. Industrial production missed forecasts. Fixed asset investment grew more slowly than forecast as the drop in real estate investment steepened, albeit with new home sales narrowing their decline. Only retail sales beat expectations with 4.8% growth . For China’s export-heavy economy, the risk of U.S. tariffs has only risen over the past two weeks as the Republican Party has taken control of the U.S. Congress and President-elect Donald Trump has filled his cabinet with China hawks. Morgan Stanley’s U.S. policy team expects Trump to impose tariffs soon after he takes office, and potentially hit Europe and Mexico along with China imports. While China is better positioned than six years ago to stave off the effects of targeted tariffs, the analysts said global duties on U.S. imports would hit China as much as targeted tariffs did in 2018.