Last November, Morgan Stanley released its year-ahead outlook for Chinese equities. It said it expected “2026 to be a year for the market to strive for stabilisation and sustainability, before potentially clearing a path for a further major breakthrough, while dealing with several domestic and external moving factors”.

Given that the MSCI China Index, which tracks Chinese firms listed at home and abroad, had already risen nearly 40 per cent in the first 10 months of 2025, the bank’s cautious optimism seemed sensible. Even so, the fact that many investors questioned why it was not more bullish attested to Wall Street’s unequivocally upbeat view of Chinese equities at the end of last year.

Goldman Sachs, which had an overweight position in Chinese stocks, anticipated gains of 20 per cent this year, underpinned in part by stronger growth in corporate earnings and advances in artificial intelligence (AI). Bank of America, which also had an overweight position, said “authorities had successfully cut off tail risks, restoring confidence in market stability.”Fast forward to today, and it is clear Morgan Stanley was not cautious enough.

Since the beginning of this year, the MSCI China Index has lost almost 14 per cent, putting it on the cusp of a bear market. Onshore stocks have also suffered. Since June 22, the CSI 300 index of Shanghai- and Shenzhen-listed shares has lost 15 per cent.

Having been one of the top-performing major equity markets in 2025, China is the worst-performing one this year along with India. The deterioration is amplified by the surge in the MSCI Emerging Markets Index, which is up about 20 per cent this year. Mainland China’s weighting in the gauge has fallen to 20 per cent, while semiconductor-heavy South Korea and Taiwan account for nearly half the index.

At Bank of America’s Asia-Pacific conference in Hong Kong last week, “investor sentiment was strongest towards Taiwan and [South] Korea” while “China sentiment was mixed”, with strong interest in AI offset by concerns about the weakness of private consumption.

The underperformance of Chinese stocks stems from a confluence of factors. The most important one is worse-than-expected economic data. Fixed-asset investment fell by a sharper-than-anticipated 7.2 per cent in the first eight months of this year while monthly growth in retail sales has not exceeded 1 per cent for five straight months, a figure Barclays called “an unprecedented stretch outside the pandemic years”.

Citigroup’s economic surprise index – which measures how often data comes in above or below expectations – for China dropped into negative territory in May, just two months after reaching its highest level since May 2023.

The unexpectedly poor performance of Chinese stocks has led analysts to downplay their bullish predictions or try to explain them away by pointing to divergences between offshore and onshore stocks. In a report on June 3, Goldman Sachs said “the [year-to-date] performance of different China indices shows the stark differences between different parts of the China equity universe”.

However, the reality is that when it comes to Chinese equities, the forecasting record of Wall Street banks is poor. False dawns and persistent volatility have spooked investors and analysts. An overly bullish view of Chinese stocks last year has given way to an excessively cautious outlook.

In Bank of America’s latest Asia Fund Manager Survey on September 15, China was the least favoured major equity market in the region along with India. That the weak domestic economy appears to be the main reason for the deterioration in sentiment casts doubt on the rationale for being bearish on Chinese stocks given that a deceleration in growth increases the probability of more stimulus.

In a report on September 3, Morgan Stanley said one of the triggers for a recovery in Chinese equities was more forceful policy support: “Any meaningful easing would likely be a positive catalyst for both Hong Kong and A-share markets.”While measures announced earlier this week to lower financing costs and boost bank lending are unlikely to materially lift credit demand, much less fix the acute problems in the housing market, they send a signal that more support is forthcoming if domestic demand weakens further.

Furthermore, it is important not to throw the baby out with the bathwater. Like China’s economy, the stock market is K-shaped. The Star Market 50 Index, the onshore gauge that offers the highest exposure to technology hardware, is up almost 14 per cent this year, outpacing the S&P 500 index.

Earnings growth for the Star Market was a staggering 187 per cent in the first half of 2026, underpinned by policy “tailwinds from tech self-sufficiency progress”, HSBC said. Moreover, it is not all about AI. A gauge of Chinese bank stocks hit a record high last month amid stabilising net interest margins and higher dividend payouts.

Passive investing no longer works in China. Investors need to focus on themes and sectors that benefit from policy support. The forecasts of Wall Street banks, moreover, should be treated with caution.