Morgan Stanley Group Inc. has downgraded its rating of the MSCI China index to “equal weight” with other Asian markets for the first time in seven years.
Potential sell-offs in A shares may drag down the performance of their counterparts listed in Hong Kong, Morgan Stanley analysts said.
They revised the rating of the index, which captures large and mid-cap mainland Chinese companies listed in Hong Kong, from “overweight” after declines in the A-share and H-share markets, the Hong Kong Economic Journal reported Friday.
“Dramatic recent outperformance has led to a deterioration in absolute and relative valuations and a technically overbought situation,” the analysts wrote Thursday.
They expect a plunge of 28 percent in the H-share market in the worst scenario if doldrums similar to those in the mainland stock market in 2008 occur.
The analysts estimated the upside for the MSCI China index at only 5 percent.
Meanwhile, the Hang Seng China Enterprises Index (HSCEI) is only 4 percent short of their target of 15,000 points.
Jonathan Garner, the investment bank’s head of Asia and emerging market strategies, said the valuation of Chinese stocks has soared to an extent that is absolutely unrealistic, as the return on equity of non-financial plays is now 11.5 percent, the worst since 2003.
Garner said investors would be better off increasing their holdings of Taiwanese stocks and sell their H shares in a defensive move.
The Shanghai Stock Exchange Composite Index dropped a combined 8.2 percent in three consecutive days, while the HSCEI slid 4.8 percent.
Translation by Vey Wong
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