Wall Street brokerages have witnessed a notable change in their stance towards Chinese stocks. Persistent deflationary pressures and geopolitical tensions have cast a shadow over the earnings outlook in the world's second-largest equity market. This shift has led to adjustments in strategies and target indices by major players like Morgan Stanley and Goldman Sachs.

Unraveling the Impact of Deflation and Geopolitics on Chinese Stocks

Persistent Deflationary Pressures and Their Implications

1: The persistent deflationary pressures in the Chinese market have been a significant factor influencing brokerages' decisions. These pressures have affected various sectors, leading to concerns about corporate earnings and market valuation. As a result, Morgan Stanley strategists have reduced Chinese equities to a slight underweight within the region. They believe that the government's reluctance to front-load excessive fiscal stimulus due to moral hazard concerns poses even stronger headwinds on corporate earnings in the coming months. 2: The impact of deflation is not limited to specific sectors but permeates the entire market. It has led to a slowdown in consumer spending and a decrease in business activities. This, in turn, has put pressure on companies to cut costs and manage their finances more carefully. The MSCI China Index, which is a key indicator of the Chinese stock market, has fallen about 15% from its recent peak, highlighting the severity of the deflationary impact.

Geopolitical Tensions and Their Effect on Earnings

1: Geopolitical tensions between China and other countries have also added to the uncertainties in the market. The victory of Donald Trump in the US election has raised concerns over higher tariffs on Chinese goods, which could directly affect Chinese companies' earnings. Morgan Stanley strategists, in their note on Sunday, have emphasized the importance of considering these geopolitical factors when assessing the market outlook. 2: The potential for US tariffs on China has led to a decrease in investor confidence and a slowdown in market growth. Companies that rely heavily on exports to the US are particularly vulnerable to these tariffs. Goldman Sachs Group Inc., for example, has trimmed its index target on the MSCI China Index to reflect the less favorable macro backdrop. This shows that geopolitical tensions are not just a short-term concern but have a long-term impact on the market.

Brokerage Strategies and Target Adjustments

1: Morgan Stanley's end-2025 target for the MSCI China Index stands at 63, slightly lower than Friday's close of 63.93. This indicates their cautious stance on the market despite some improvement in the policy outlook in October. The brokerage has scaled back its underweight position on China, but they still remain concerned about the long-term impact of deflation and geopolitical tensions. 2: Goldman Sachs, on the other hand, has reduced its target on the gauge to 75 from 84. While the firm remains overweight on Chinese equities, it has noted that potential US tariffs could lead to lower earnings growth. This shows that even though they are optimistic about the long-term prospects of the Chinese market, they are also aware of the risks posed by geopolitical factors. Additionally, Goldman has downgraded Hong Kong stocks to underweight given the weak property and retail sectors and the less policy flow-through from China's domestic easing.