By Jiahui Huang

Chinese equities have been out of favor among many investors for the past few years. However, the tide appears to be turning, driven by strong corporate profits, enthusiasm over artificial intelligence and an apparent easing of regulatory pressure from Beijing.

"China is back on the radar, at least in terms of investor interest," Goldman Sachs strategists wrote in a note.

Investor interest and engagement in Chinese equities are "arguably at the highest" since the market's historic peak in early 2021," they said.

Hong Kong's benchmark Hang Seng Index, home to many Chinese firms, has risen 17% so far this year, outperforming most major emerging markets. In contrast, onshore indexes have lagged, with the benchmark Shanghai Composite Index up just 0.5%.

Analysts attribute this to foreign investors favoring offshore Chinese shares, though they see potential for A-shares to catch up. The MSCI China Index, which tracks large- and mid-cap stocks across A- and H-share markets, has gained 16% so far in 2025.

One major catalyst has been the emergence of a homegrown AI startup DeepSeek, which has impressed the tech industry with a large language model it claims rivals OpenAI's ChatGPT while using less advanced chips.

"DeepSeek has been a game-changer on many fronts," said Pruksa Iamthongthong, deputy head of Asia-Pacific equities at Aberdeen Investments. The company's cost-efficient model has galvanized China's tech and internet sectors, fueling investment and new product releases, she added.

China's improving economic outlook has also bolstered sentiment.

The prolonged property market slump and disappointment over policy response has long dampened investor confidence. However, recent data suggests some green shoots in the economy, prompting financial institutions such as HSBC and Morgan Stanley to upgrade their growth forecasts.

A perception of a more business-friendly Beijing is another positive factor.

The absence of major regulatory crackdowns--like those that rippled across the tech sector in 2021--and a recent meeting between President Xi met and top business leaders have been interpreted as signals of a more relaxed regulatory environment.

Strong corporate results have further supported the cautiously brighter mood. Major companies, including Tencent, Xiaomi and Alibaba, have posted robust fourth-quarter earnings growth.

Morgan Stanley strategists have raised their targets for Chinese indexes, citing stronger earnings and other positive upsides. The brokerage increased its year-end target for the Hang Seng Index to 25800 and for the blue-chip CSI 300 Index to 4220, implying potential gains of 9% and 8%, respectively, from current levels.

Despite the optimism, concerns remain about the sustainability of this turnaround. Trade tensions with the Trump administration, fears of deflation in China as well as still-subdued domestic consumption could sour sentiment again.

Morgan Stanley strategists led by Laura Wang believe China's equity market will be less affected by the reciprocal tariffs than the broader economy, which is better positioned to weather the impact. However, they cautioned that unexpected escalations in U.S.-China tensions--particularly related to investment restrictions--could trigger a significant market setback.

Citing earnings indicators, Goldman Sachs strategists say most investors seem to share their view that the recovery is likely to have more staying power than previous rebounds.

That said, they expect "the bull market to slow and profit-taking pressures to build as the U.S.-China policy and geopolitical calendar turns active once again in the coming weeks."

Write to Jiahui Huang at jiahui.huang@wsj.com

(END) Dow Jones Newswires

March 26, 2025 06:54 ET (10:54 GMT)

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