As the summer holidays end, investors in China are coming to accept that consumption and growth will remain sluggish for a while. JPMorgan on Wednesday downgraded its opinion on Chinese stocks to neutral from overweight, citing a challenging outlook. A team led by emerging markets equity strategist Pedro Martins indicated that the firm has increased its overweight recommendations on other emerging markets. Despite the downgrade, JPMorgan still holds 18 China stocks in its global emerging markets model portfolio. The analysts highlighted a preference for select Internet names due to growth at a reasonable price and rising shareholder returns, as well as AI thematic plays once the current consolidation completes.

In contrast, the consumption and real estate sectors in China remain hindered by domestic challenges with limited bottom-up stock picking opportunities. Chinese policymakers have acknowledged the softness in domestic demand but have yet to take significant action to boost consumer sentiment. Uncertainties about China's economic outlook range from tensions with the U.S. to lingering deflation pressure. Unlike in the U.S., consumer prices in China have barely risen in the past year, impacted by the real estate slump and concerns about future income. According to analysts polled by Reuters, China's consumer price index for August is expected to have increased by just 0.7% year-on-year.

JPMorgan’s downgrade follows Nomura's recent reduction of MSCI China to neutral from overweight, attributing it to consistent disappointments in economic support and the property sector. Nomura's team, led by Asia ex-Japan equity strategist Chetan Seth, expressed concern about the U.S. elections potentially impacting the market. They noted that attractive valuations and possible short-term rallies driven by stimulus expectations prevented them from cutting China stocks to underweight. While U.S.-China relations have stabilized over the past year, uncertainty around the U.S. presidential election in November has led Beijing to delay domestic stimulus.

U.S. national security advisor Jake Sullivan visited Beijing in late August for official meetings and emphasized the importance of high-level communication in managing the bilateral relationship responsibly. During previous periods of escalating U.S.-China trade tensions, the MSCI China index fell, but China's utilities sector showed an average return of 12.8%. Following its China stock downgrade, JPMorgan added shares of state-owned utility operator CR Gas while removing shares of PDD, China Construction Bank, and Kingdee International. The bank's updated global emerging markets model portfolio includes internet-focused names Alibaba, Tencent, Kuaishou Technology, and Meituan, all rated overweight by JPMorgan.

Among its emerging markets growth and value picks, JPMorgan has identified only one Chinese stock that appears on both lists: Hong Kong-listed short video company Kuaishou. The video app, a smaller rival to TikTok owner ByteDance, reported better-than-expected revenue and earnings for the second quarter, according to FactSet. Average daily active users rose to 395.3 million, up from 376 million a year ago. JPMorgan has set a price target of 65 Hong Kong dollars on Kuaishou, implying an upside of over 60% from Thursday's close, despite the stock being down more than 20% for the year so far. The Wall Street investment bank selects its value stock picks based on cash flow and potential upside, and growth stocks based on historical and expected sales increases.