Morgan Stanley has upgraded China's equities amidst optimism about the country relaxing restrictions to slow down the spread of Covid-19.
"Multiple positive developments alongside a clear path set towards reopening warrant an upgrade and index target increases for China," the brokerage said in a note.
MSCI China's return on equity (ROE) is likely to rise from 9.4 per cent to 11.1 per cent by the end-2023.
The recovery is set to be bumpy "as earnings pressure continues into early next year", it said.
Morgan Stanley upgraded China to overweight from an equal-weight position.
"Our China evaluation framework finally shows the majority of factors improving concurrently, with the latest acceleration of Covid relaxation, property market stabilization, regulatory reset wrapping up, as well as early signs of US/China bilateral communications accelerating.
"We believe the equity risk premium could also improve," the brokerage said.
Morgan Stanley raised its end-2023 targets for the Hang Seng Index to 21,200, 8 per cent above the current levels.
The brokerage, however, warned that the path ahead could be bumpy following the extreme underperformance of the last two years and the disengagement of certain segments of the global investor base.
"Pressure on earnings should continue through 1Q2023, while market volatility could stay high owing to wide swings in sentiment between over-optimism for a fast reopening and , at times rapid disappointment regarding a seemingly slow and zigzagging move towards Covid-zero exit,' it said.
Moreover, US-China tensions could resurface ahead of the next US presidential election in 2024.
And long-term structural concerns remain surrounding policy direction, priorities for the economy and private sector, and balance between macro growth and social agenda, as well as security, the note said.
"It could take at least another 6-12 months for further clarity to emerge regarding these concerns."