(Bloomberg) -- The momentum behind one of the world’s biggest stock rallies in China will likely abate, according to Morgan Stanley.

Investors shouldn’t chase the recent gains further at the index level, strategists at the US bank led by Laura Wang and Jonathan Garner wrote in a note Tuesday. They recommended instead pursuing single-stock and thematic opportunities given improved investor sentiment.

“Global investors’ fund positions have already improved; meanwhile, there is less urgency to diversify away from the US and Japanese markets, given that the geopolitical, yield, and FX factors are abating or reversing,” they wrote. “We also see near-term technical overbought signals, which could deter further buying by global quant funds.”

The rebound of Chinese equities from multiyear lows is stoking optimism that the market has bottomed, with analysts at Goldman Sachs Group Inc. saying that a fear of missing out is building among traders. Market watchers though remain divided, with some pointing to weak earnings growth and a deflating property sector as reasons for staying on the sideline. 

The onshore CSI 300 Index lost as much as 0.7% Wednesday, after jumping to its highest level since October in the previous session. The Hang Seng Index was on track to fall for a second day, following a 10-day winning streak. 

Benchmark gauges in Hong Kong have all rallied more than 10% since the end of March as cheap valuations, improving macro data and Beijing’s supportive policy stance attract inflows. The Hang Seng Index was one of the best performers among major gauges in April.

The rally has propelled the 14-day relative strength indexes of both the Hang Seng Index and Hang Seng China Enterprises to above 70, a level that many regard as showing the gauges are overbought.

China’s consumption levels and the housing market likely need more time to pick up, implying ongoing pressure on deflation and corporate earnings, the Morgan Stanley strategists wrote. The pace of real estate policy change is likely to remain “rather modest,” they added.

Skeptics Abound

“While Beijing’s vow to deepen reform and expand opening-up eased some investor concerns about economic uncertainty, it remains a question of debate whether the policies introduced so far will be effective in stemming the property downturn,” said Shen Meng, a director at Chanson & Co. “In addition, it seems Xi’s trip to France failed to achieve the expected outcome of creating a divide among Western countries, especially in economy and trade.” 

The real estate market has remained depressed even as Beijing vowed to deal with unsold properties, and more cities eased home purchase restrictions to revive sales. 

There are more pessimists. Union Bancaire Privee said the recent outperformance of the Hang Seng is likely driven by flows from inside China, and might not be backed by fundamentals. Bank of America Securities warned that investor conviction remains low and the rally could be derailed by factors such as geopolitical tensions, weaker macro data and policy disappointment. 

Morgan Stanley was among the first Wall Street banks to downgrade Chinese stocks — doing so in August as the market rout deepened — and has since kept its equal-weight rating. The firm further slashed targets for major Chinese stock benchmarks in January. The MSCI China Index has rebounded 14% since then.

Looking ahead, Morgan Stanley also sees geopolitical uncertainty as a headwind for Chinese equities given looming US elections and EU trade controversy.

(Updates with latest stock moves, a quote, and more background.)

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