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

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Chinese stocks face mounting challenges as earnings have yet to pick up, while U.S. trade tensions loom.

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 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.

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.

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.

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