Morgan Stanley believes that China and Hong Kong equities have outperformed in a volatile environment and that recovery conditions in August are likely to improve

Overview

This report discusses the relative strength of China and Hong Kong equities amid global market turbulence and whether there is a sustainable recovery thesis going forward. Morgan Stanley believes that recent performance improvement has mainly come from financing short covering and sustained northbound inflows, rather than rapid re-entry of offshore capital into China. Looking ahead to late July and August, the report sees improving conditions for a recovery in Hong Kong, but says continued improvement in domestic earnings revisions, AI commercialization progress, and the stability of global rates and risk appetite is still needed.

Core views

The core view is that China's short-term downside risk is easing and positive catalysts are gradually clustering over time, but a meaningful further rebound is not a given. The report suggests that the impact of the e-commerce price war on profitability may be nearing a peak, that AI commercialization outlook continues to improve, and that the heavy IPO share unlock pressure seen in July may gradually be digested. At the same time, global markets still need to stabilize, especially the Federal Reserve policy path, interest rates and bond yields, US mega-cap technology capex plans, and de-leveraging pressure in high-beta market segments.

Analysis framework

The report applies a market strategy framework, breaking recent market performance into four factors: flows, positioning, domestic fundamental catalysts, and global risk appetite. The author does not interpret the recent outperformance as foreign capital inflow per se, and instead emphasizes the role of financing short covering and northbound flows at the liquidity level, then further assesses whether earnings and AI-related catalysts around August can support a more sustainable recovery.

Methodology notes

• Market strategyLiquidity and positioning analysis

  Financing short covering and repair of underweight positioning

  The report states that Hong Kong and China had previously been used by some global investors as sources of financing shorts while they added to Korea, Taiwan, and Japan; when those markets sold off, short pressure on Chinese assets eased, supporting relative outperformance.

• Market strategyCatalyst tracking

  Earnings, AI commercialization, and unlock pressure

  The report treats second-quarter e-commerce earnings, AI commercialization progress, and digestion of IPO share-unlock pressure as key checkpoints for an August recovery in Hong Kong.

• Macro and cross-marketGlobal risk-on conditions

  Rates, technology capex, and de-leveraging pressure

  The report says a further rebound also requires stable global rates and bond yields, a clearer Federal Reserve path, confirmation of expanded capital spending plans by U.S. megacap technology companies, and contained de-leveraging pressure in high-beta market segments.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• China's stock market

  Core research focus

  Strengths

  Recent relative performance has improved; underweight positioning creates potential reallocation space; financing short covering has reduced pressure.

  Weaknesses

  Foreign capital has not clearly returned in a large-scale manner; momentum in earnings revision still needs to bottom.

  Comparison

  Outperformed regional and global peers over the past week, while volatility rose in most other markets.

  Risks

  Deterioration in global risk appetite, continued downside in earnings revisions, and renewed foreign investor caution.

• Hong Kong stock market

  Key recovery watch market

  Strengths

  Northbound flows provide stable liquidity; easing of e-commerce profitability, AI commercialization, and IPO unlock pressure could provide catalysts.

  Weaknesses

  Still likely to be affected by global market volatility in the short term.

  Comparison

  The report sees Hong Kong market conditions in August as more supportive of a meaningful recovery.

  Risks

  IPO unlock pressure may not be digested as quickly as expected; e-commerce and technology earnings may disappoint.

• China internet and AI-related companies

  Potential source of catalysts

  Strengths

  The damage from the e-commerce price war to profitability may be near its peak; Tencent Hunyuan-related free AI agent launches; Alibaba Cloud and overall EBITDA are expected to exceed market expectations.

  Weaknesses

  AI commercialization is still in a proving phase, and earnings realization will take time.

  Comparison

  Relatively more sensitive than traditional sectors to expectations for AI commercialization and cloud business.

  Risks

  AI monetization may fall short of expectations, competition may intensify, and valuations may be affected by global technology stock volatility.

Key data

• Report date2026-07-09Cover time is July 9, 2026, 12:01 AM GMT.
• AnalystLaura WangThe author is the Equity Strategist at Morgan Stanley Asia Limited.
• Recent performanceHong Kong and China outperformed regional and global peers over the past weekThe report notes that volatility increased significantly in most other markets.
• Main capital driversFinancing short covering, northbound flowsThe report explicitly does not consider the recent outperformance to be evidence of rapid foreign capital re-entry into China.
• Key time windowLate July to AugustThe report deems this period critical to whether China's market can sustain a recovery.
• Morgan Stanley global equity rating distributionOverweight/Buy 42%, Equal-weight/Hold 43%, Underweight/Sell 15%The table is as of June 30, 2026, and covers 3,668 stocks and ADRs.

Impact & implications

For investors, the implication is that if a portfolio is significantly underweight Chinese assets, investors can gradually focus on high-quality names with strong fundamentals benefiting from earnings recovery and AI commercialization catalysts amid short-term volatility. However, the report also warns that the market has not yet entered a stage of a clear and broad reversal, and any further rebound still depends on joint improvements in domestic earnings trends and global financial conditions.

Risks

• Short-term volatility may persist, and global markets are still seeking stability.
• If domestic earnings revision momentum fails to bottom, the recovery foundation in China may be insufficient.
• If AI commercialization progress is below expectations, the catalyst effect for technology and internet segments may weaken.
• If the Federal Reserve policy path remains unclear and rates and bond yields become volatile again, global risk appetite may remain under pressure.
• If U.S. megacap technology companies' expanded capex plans are not confirmed, sentiment in global AI and technology chains may be affected.
• If de-leveraging pressure in high-beta market segments is not controlled, it could drag on overall risk assets.
• Morgan Stanley discloses possible business relationships with covered companies, and investors should treat this report as only one factor in investment decisions.

What to watch

• Whether Hong Kong shows a more sustainable rebound in late July to August.
• Whether second-quarter e-commerce company results confirm that the earnings impact of the price war has peaked.
• Progress in AI commercialization, especially Tencent Hunyuan, Alibaba Cloud, and related EBITDA performance.
• Whether the July IPO share-unlock pressure has largely been digested by the market.
• Whether domestic earnings revision momentum has bottomed and improved.
• Whether Federal Reserve policy path, interest rates, and bond yields become further stable.
• Whether U.S. megacap technology companies confirm plans to expand capital expenditure.
• Whether summer sees containment of de-leveraging pressure in high-beta market segments.