Why Morgan Stanley Reduced China’s First Quarter GDP in 2022

A woman shows her swab and test kit to a health worker before receiving a nucleic acid test for Covid-19 at a private test site on January 17, 2022 in Beijing, China.

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The economic cost of China’s zero-Covid policy is increasingly expected to outweigh its benefits, according to US investment bank Morgan Stanley.

China’s zero tolerance for Covid leaves the country at a disadvantage compared to other countries with an endemic strategy, its top Chinese stock strategist Laura Wang told CNBC’s Emily Tan.

In January, the US investment bank lowered its forecast for China’s first-quarter GDP – lowering estimates to 4.5% year-on-year growth, from its previous forecast of 4.9%.

“We [started] to see a lot of pressure from omicron, “said Wang.” This year, the shock absorption from growing exports may not be as high as… last year, because a lot of other countries and markets [are] already reopens. “

“We therefore expect greater earnings consensus reduction. At present, we believe that investors are still too positive with their expectations for corporate earnings,” she said.

Wang said the bank favors Class A stocks over MSCI China for 2022. Class A stocks are yuan-denominated stocks in mainland Chinese-based companies traded on Chinese stock exchanges in Shanghai and Shenzhen.

The bank expects the CSI 300 index to reach 5,250 by the end of the year, and the MSCI China index to reach 95 over the same period. The CSI 300 is currently trading at around 4,680 after losing around 5% this year. The MSCI China index, which foreign investors often use as a benchmark, hovers at around 82 – lower by 1.3% year-to-date.

According to Morgan Stanley’s report on January 16, “increasing uncertainty from omicron scattering on land [and] risks of real estate market default “are some reasons to be wary of Chinese stocks.

Morgan Stanley maintained its initial 2022 full-year forecast of 5.5% growth for China, but noted that it continues to see downside risks from potential shutdowns, as “the loss in Q1 is unlikely to be offset.”

The bank does not expect a shift in zero-Covid policy until the second half of 2022.

“The greatest pressure would be borne by private consumption, as the escalation of social distancing and local / regional closure may become inevitable. A de facto ‘stay at home’ lunar New Year (LNY) is more and more likely given China’s’ Covid-zero ” strategy, “Morgan Stanley analysts said.

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China reported its first omicron Covid case in December and continues to see communities scattered across cities. Beijing officials also remain in “full emergency” ahead of the Winter Olympics and New Year’s travel season.

Despite lowering its expectations for first-quarter GDP growth, Morgan Stanley noted that “recovery could regain a foothold amid political easing.”

Earlier this week, the People’s Bank of China lowered its 14-day reverse repo rate to 2.25%, down from 2.35%, to “maintain stable liquidity ahead of the lunar new year,” Reuters reported.

Concerns about ‘political misfortune’

Analysts generally expect China’s economy to recover after the first quarter due to expected economic stimuli and monetary easing.

China is likely to outperform other markets this year, said Catherine Yeung, chief investment officer at Fidelity International.

Upward surprises for US inflation and the Fed’s sluggish policy shift may also trigger higher volatility in growth stocks.

The biggest risk for China is “political misfortune” of zero-covid tolerance – “if it does not support fast enough [or] whether it’s too supportive, “she told CNBC.” But it’s not just the political risk for China, it’s really a global risk in terms of the direction the central banks are taking. “

Morgan Stanley sees “downward risk of FY22 growth from housing”, but chose four stocks in the real estate sector that are considered high-quality developers in “safe harbor” away from potential market turbulence.

The bank’s top picks are China Overseas Land & Investment Limited, China Resources Land Limited, Longfor Group and CIFI.

The Wall Street bank remains optimistic about the technology hardware and semiconductor industry, but warned against Chinese ADRs, e-commerce and Internet stocks.

“Upward surprises for US inflation and the Fed’s sharp policy shift may also trigger higher volatility for growth stocks,” the bank wrote.

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