China's Stocks Poised for Sustained Rally as Stimulus Measures Take Effect

According to a recent report by Morgan Stanley, Chinese stocks are set to experience a more "sustained rally" in the coming months, driven by the wave of stimulus measures and signals announced by the Chinese government last week. The investment bank's analysts believe that the policy pivot has exceeded their expectations, with aggressive monetary easing and unprecedented measures aimed at stabilizing and supporting the stock market, as well as halting the decline in the property market.

Unlocking the Potential of China's Equity Markets

Riding the Wave of Stimulus Measures

Morgan Stanley's analysts predict that Chinese stocks could see at least a 10% rally in the near term, with the potential for an even more sustained rally in the next phase. The bank's experts believe that valuations could reach levels last seen during the economy's reopening from November 2022 to March 2023, provided there is further clarity on earnings improvements amid a broader growth recovery and efforts to stamp out deflation.The recent policy announcements by the Chinese government have been a game-changer for the country's equity markets. The central bank's decision to cut the reserve requirement ratio (RRR) of cash that banks hold by 50 basis points, coupled with plans for interest rate cuts, have provided a much-needed boost to the market. Additionally, the high-level meeting where top leaders called for halting the property market decline and strengthening fiscal and monetary policy has further reinforced the government's commitment to supporting economic growth.

Identifying Stocks Poised to Benefit

In light of these developments, Morgan Stanley has indicated its preference for certain stocks that are set to benefit from the easing measures. The bank's analysts have conducted stock screens to identify the most promising opportunities.One of the screens focused on Hong Kong-listed stocks that trade at deep discounts to their A-share counterparts (those listed in mainland China). These stocks are expected to benefit from the central bank's announcements, as they can leverage the easing measures to their advantage.Another screen looked for stocks with a current dividend yield below 2.25% (the relending rate), but with a free cash flow yield "meaningfully" above 4%. These firms are likely to be more motivated to increase their dividend payouts, buy back shares, or increase their shareholdings, as the cost of borrowing is now lower than their free cash flow yield.

Anticipating Further Policy Support

Morgan Stanley's analysts also expect additional policy support from the Chinese government in the coming months. They anticipate a supplementary budget to be announced in late October, which will focus on supporting consumption and local government financing. The bank also sees another 10 to 20 basis point rate cut and a 25 to 50 basis point RRR cut by the end of the year, further bolstering the market's prospects.As the Chinese government continues to implement a range of stimulus measures and policy initiatives, the country's equity markets are poised to experience a more sustained rally in the months ahead. Investors and market participants will be closely watching the developments, as the potential for significant gains in Chinese stocks becomes increasingly apparent.