(Bloomberg) -- UBS Group AG raised its recommendation on a key Chinese stock index to overweight in a rare upgrade call this year, underscoring the tentative optimism that the market is finally on the mend.

“The largest stocks in the China index have been generally fine on earnings and fundamentals,” strategists including Sunil Tirumalai wrote in a Tuesday note. UBS is now even more positive on earnings given early signs of a pickup in consumption, with the possibility of household savings flowing into spending and eventually markets, the note said. 

The bullish call for the MSCI China Index arrives at a pivotal time. Shares had been emerging from a multi-year slump, thanks to green shoots in the economy as well as signs of improving corporate performance. However, lingering risks from geopolitical tensions and potential regulatory whiplash have made investors wary of going all-in on the asset class. 

Chinese equities have rebounded in recent months, with the MSCI China Index up more than 13% since a January trough and the Hang Seng Index about 12% higher.  

In addition to earnings, the strategists highlighted tailwinds from the so-called national team — state-related funds that intervene in the stock market — and a slew of positive surprises on dividends and buybacks from local firms. 

Read: China Vows to Tighten Stock Market Supervision as Rebound Stalls

Their revisions, which also included raising Hong Kong stocks to overweight, stand out as brokerages have been reluctant to boost their index targets or raise recommendations this year. 

The reservations are likely due to caution from misplaced calls during the late 2022 reopening frenzy. Most Wall Street banks had turned bullish back then, only to be wrong-footed as the rally fast lost momentum. Morgan Stanley and UBS were among those to downgrade the nation’s shares to neutral in August 2023 as a selloff extended. Since then, the MSCI gauge lost roughly 20% of its value through the January low.   

Portfolio Shift 

In the Tuesday report, the Swiss bank also downgraded the tech-heavy markets of Taiwan and South Korea to neutral. The strategists said the sustained outperformance of the chip sector has led to “decade-high premiums to rest of the universe.” 

The rotation out of tech sectors has been gathering momentum as the Federal Reserve looks set to keep rates higher for longer in a blow to stocks with frothy valuations.   

The changing preference reflects a broader shift underway among investors. Sentiment on China stocks is improving “on the margin” as allocations tick up for the second month in a row, according to Bank of America’s monthly fund manager survey. Goldman Sachs Group Inc. strategists said onshore Chinese share have the potential to climb about 20% on efforts to boost shareholder returns.  

UBS noted how despite a weak property market, earnings have held up. Liquor maker Kweichow Moutai Co. reported higher-than-expected earnings for 2023. Delivery giant Meituan’s fourth-quarter revenue and net income beat estimates. 

The 12-month forward earnings estimate for the MSCI China Index has risen 1.7% this month, rebounding from the lowest since end-2022, according to data compiled by Bloomberg. 

The biggest risk to the stocks now is “heightened geopolitical noise in the run-up to US elections,” the strategists wrote. 

--With assistance from Abhishek Vishnoi and Ishika Mookerjee.

(Updates strategists’ track record, adds more background)

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