Here's why Morgan Stanley is cutting its forecast for China's first quarter GDP

In January, the U.S. investment bank cut its forecast for China's first quarter GDP — lowering estimates to 4.5% growth year-on-year, from its previous prediction of 4.9%.

"We [started] to see a lot of pressure from omicron," said Wang. "This year, the cushion from growing exports may potentially not be as high as … last year because a lot of other countries and markets [are] already reopening."

"We are therefore expecting bigger earnings consensus reduction. At this point, we think investors are still being too bullish with their expectation about corporate earnings," she said.

Wang said the bank favors A-shares over MSCI China for 2022. A-shares are yuan-denominated shares of companies based in mainland China, which are traded in Chinese stock exchanges in Shanghai and Shenzhen.

The bank expects the CSI 300 index to reach 5,250 by year-end and the MSCI China index to reach 95 in the same period. The CSI 300 is currently trading at about 4,680 after losing about 5% this year. The MSCI China index, which foreign investors often use as a benchmark, is hovering at about 82 — lower by 1.3% year-to-date.

According to Morgan Stanley's report on Jan 16., "rising uncertainty from onshore omicron spread [and] property market default risks" are some reasons to stay cautious toward Chinese equities.

Morgan Stanley maintained its initial 2022 full-year forecast of 5.5% growth for China, but noted that it continues to see downside risks from potential lockdowns as "the loss in Q1 is unlikely to be compensated."

The bank does not expect a shift in the zero-Covid policy before the second half of 2022.

"The greatest pressure would be borne by private consumption, as step-up in social distancing and local/regional lockdown may become inevitable. A de facto 'stay-home' Lunar New Year (LNY) is increasingly likely given China's 'Covid-zero' strategy," Morgan Stanley analysts said.

China reported its first omicron Covid case in December and continues to see community spread across cities. Beijing officials are also remaining in "full emergency mode" ahead of the Winter Olympic Games and Lunar New Year travel season.

Despite cutting its first quarter GDP growth predictions, Morgan Stanley noted that "recovery could regain footing amid policy easing."

Earlier this week, the People's Bank of China cut the 14-day reverse repos rate to 2.25%, down from 2.35%, in order to "maintain stable liquidity ahead of the Lunar New Year, Reuters reported.

Analysts generally expect China's economy to pick up after the first quarter due to anticipated economic stimulus and monetary easing.

China will likely outperform other markets this year, said Catherine Yeung, investment director at Fidelity International.

The biggest risk for China is "policy mishap" on zero-Covid tolerance — "whether it's not being supportive soon enough [or] whether it's being too supportive," she told CNBC. "But that's not just the policy risk for China, that really is a global risk in terms of the direction that central banks do take."

Morgan Stanley sees "downside risk to FY22 growth from housing," but picked four stocks in the property sector that are considered as high-quality developers in the "safe harbour" away from potential market turbulence.

The bank's top picks are China Overseas Land & Investment Limited, China Resources Land Limited, Longfor Group and CIFI.

The Wall Street bank remains bullish on technology hardware and the semiconductor industry, but cautioned against Chinese ADRs, e-commerce and internet stocks.

"Upside surprises for U.S. inflation and the Fed's hawkish policy shift could also trigger higher volatility to growth stocks," the bank wrote.