(Oct 5): Having endured a long stretch of losses, stocks in emerging markets and Asia excluding Japan are close to completing their bear-market cycles, according to Morgan Stanley.

It’s highly likely these markets are bottoming amid “abundant” signs of extreme selling, the investment bank’s strategists including Jonathan Garner wrote in note on Tuesday (Oct 4). They upgraded emerging-market and Asian ex-Japan stocks to "overweight" from "equal-weight".

The reassessment from Garner and team, which correctly predicted deepening routs in emerging and Chinese markets earlier this year, follows the longest-ever peak-to-trough run for the MSCI Emerging Markets Index as a surging dollar and China’s stringent Covid-19 restrictions took a toll.

Morgan Stanley expects the MSCI emerging-market benchmark, which has slumped for five straight quarters and lost 26% this year, to rally about 12% from Tuesday’s close until June.

“A lot of wood has been chopped” and “it’s time to plant saplings for the next cycle”, Garner and his colleagues wrote. Investors should “rotate towards proven early-cycle beneficiaries”, they added, also upgrading South Korean, Taiwanese equities as well as Asia’s semiconductor and tech hardware sectors to "overweight".

The MSCI Emerging Markets Index is poised for its fourth annual underperformance versus a gauge of developed-market equities. China takes the bulk of the blame for the historic downturn in emerging-market shares, with the nation’s Covid-zero policy, property crisis and tensions with the West rendering its markets one of the world’s worst performers.

Those issues will keep China from outperforming over the next 12 months, even as it is likely to participate in an emerging-market rebound due to its oversold state and low valuations, Morgan Stanley said.

To be sure, Chinese stocks listed in Hong Kong were Asia’s best performers on Wednesday, as trading in the financial hub resumed after a holiday. The benchmark Hang Seng Index jumped more than 6%, playing catch-up to a global rally that came after weak US economic data spurred bets that the US Federal Reserve won’t be too aggressive in raising rates.

Meanwhile, Garner’s US colleague Michael J Wilson — one of Wall Street’s biggest equity bears — still sees further downside in US equities. He has, however, predicted an eventual low for the S&P 500 coming later this year, or early next, at the 3,000- to 3,400-point level.

A framework of 10 signposts that Morgan Stanley uses to identify market inflection points now indicates a high probability for a trough to form for emerging-market and Asian stocks, signaling a “compelling” buying opportunity, according to the note.

South Korea and Taiwan are the “highest conviction opportunities into a new cycle”, as both markets have substantially underperformed this year, and a turning point in the semiconductor inventory cycle is near, Garner’s team wrote.

In separate reports, the US investment bank also upgraded stocks including South Korean chipmaker SK Hynix Inc, Apple Inc supplier LG Display Co, and its Taiwanese rival AUO Corp. Taiwan Semiconductor Manufacturing Co is among its top picks. Asian chip stocks rallied on Wednesday.

Morgan Stanley lowered its views on some of this year’s outperformers, downgrading India and Malaysia to "underweight", and moving Indonesia, Singapore and Chile to "equal-weight". The bank also raised Mexico to "neutral".