China stock sentiment improves, but Morgan Stanely recommends caution

Investing.com-- Sentiment towards mainland Chinese stock markets improved over the past week, as hopes of more government stimulus and some positive economic data helped spur gains in regional markets after a middling start to the second quarter. 

China’s blue-chip Shanghai Shenzhen CSI 300 index and the Shanghai Composite index were trading up between 1.4% and 2% this week, outpacing their broader Asian peers. Gains came especially after stronger-than-expected gross domestic product data for the first quarter, which showed strong economic growth in China.

Morgan Stanley analysts noted that while sentiment had improved, risks in Chinese markets still persisted, particularly from more stock market regulation, weakness in the Chinese economy and a soft outlook for earnings. 

To this end, they warned that the recovery in Chinese markets may not sustain, especially with deflationary pressures and broader, geopolitical tensions also stemming sentiment. 

Morgan Stanley analysts recommended stock-picking and more thematic investing to weather further weakness in Chinese stock indexes. Two main themes the analysts cited were reforms in state-owned enterprises, as well as Chinese multinational firms expanding their overseas operations, especially in the face of slowing domestic growth. 

They expected largely range-bound market conditions for China in the near-term, due to persistent deflationary pressures and rising geopolitical uncertainty, especially with regards to increased U.S. regulatory scrutiny of Chinese firms. 

While China's GDP did beat expectations, it still remained relatively subdued, especially when considering the impact of a persistent deflationary trend on the reading. Industrial production and retail sales readings for March also showed that this momentum was already running low, and the Beijing needed to roll out more stimulus measures to support growth.