China stocks: Morgan Stanley says AI rally boosts sentiment, but headwinds remain

Morgan Stanley (NYSE:MS) analysts said sentiment towards mainland Chinese stock markets was boosted by optimism over the country’s artificial intelligence capabilities after the release of DeepSeek.

But the investment bank noted a growing divergence between technology and non-tech sectors, as other economic conditions in China still remained mostly weak. Deflation was a key point of contention, as data for January showed little pick-up in inflation.

China’s Shanghai Shenzhen CSI 300 was trading up 2.2% since mid-January, while Hong Kong’s Hang Seng index was up 13.5%.

In the near-term, MS expects divergent performance to continue, with deflation likely to weigh on more economically sensitive, non-tech sectors. But an extended recovery in China’s technology sector is expected to continue.

Chinese tech shares rallied through late-January, following the release of DeepSeek R1- an AI model that appeared to match rival offerings such as OpenAI, while using older hardware and a much smaller budget.

The model, which was followed up by more AI releases from China’s internet giants, ramped up optimism that China still remained a competitive force in the AI industry despite U.S. curbs on technology exports to the country.

This sparked an extended rally in domestic shares, as investors bet that a wide swathe of sectors- such as tech, utilities, and energy- will benefit from AI exposure.

MS analysts said further bullishness in Chinese markets will be largely driven by developments in geopolitics- especially Beijing’s relationship with Washington- as well as local stimulus measures, and the pace of AI adoption.

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Recent media reports showed Beijing is also attempting to improve U.S. relations by playing the role of a peace broker between Russia and Ukraine.