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Morgan Stanley 2025 Asia EM Equity Strategy Summary

Key Headlines

• Cross-Asset Outlook: China bonds likely outperform equities in 2025 due to ongoing deflation, bull curve flattening, and CNY weakening against USD.
• Secular Bear Market: China equities remain in their 5th year of a secular bear market. Defensive stocks focusing on dividend yield, sustainability, and quality cash flows are favored.
• Policy Trajectory: Base case is cautious with gradual policy easing. A mild fiscal expansion of ~Rmb2Tn planned, but persistent deflation risk remains due to US tariffs and domestic constraints.

Asset Allocation

1. Bonds (Overweight):

   • Expect bull flattening; 10-year CGB yields likely fall further, converging with JGBs.
   • Base case positioning: Receive 5-year CNY NDIRS; Long 6m USD/CNH 7.50–7.60 call spread.

2. Equities (Equal-weight/UW China):

   • Maintain dividend-focused positioning, screen for high dividend yield, FCF sustainability, and low-beta defensive stocks.
   • Quant factor screens prioritize Total Yield, Dividend Growth, Sentiment Composite in low growth environment.
   • Select 32 high-earnings stocks, 18 dividend-focused stocks, and 22 quant-ranked growth stocks.

3. FX (Cautious):

   • Short CNH/INR due to risk of US tariffs. CNY likely weakens vs USD, though managed by capital controls.

Critical Drivers for 2025

• Nominal GDP Growth: Expected to slow below 4% YoY due to policy gradualism and external pressures.
• Inflation/Deflation Reinforcement: Persistent weak demand → downward spiral in consumer/industrial activity.
• US-China Geopolitical: Incoming Republican administration introduces trade/tech risks. Tariffs may exacerbate deflation.

Timeline & Scenarios

1. Base Case (Mid-2025 Peak):

   • CNY targets 7.60; 10-year CGB yield falls to ~1.5%.
   • Equities underperform bonds on secular bear market timeline.

2. Bull Case (if policy pivot):

   • Deep fiscal stimulus, consumption-focused, exits gradualism.
   • Reverses deflation loop: bond yields rise, equities rally sustainably.

3. Bear Case (Skewed policy focus):

   • Tech/industrial stimulus → lower capital efficiency. Persistent deflation → entrenched bear market.

Market Timing Signals

• Social stability indicator stabilizing temporarily (Q4 2024) → risk of transience.
• Economic Synchronizers:
  • China bond curve flattening signals risk aversion.
  • Low 10-year yield vs. manufacturing PMI dissolves growth confidence.

Policy Reminder

• Analysts report potential COI in China coverage; could impact research objectivity during major policy shifts.

Exhibits Summary

1. Exhibit 1: Bond/equity divergence (Bull market in bonds since 2021).
2. Exhibit 23: Average dividend yield (3%) weakens yield environment.