China’s Stealth Rally

Although China has become one of the most polarizing stock markets in recent years, we believe there remain significant opportunities that investors should not write off. Many investors perceive China’s economy is in shambles, is plagued by geopolitical tensions, and incorporates overbearing regulatory crackdowns. This perception has led to near-record underweights in Chinese equities among global investors and huge valuation discounts relative to other markets.

Perception versus Reality

Contrary to this bleak view, Chinese stocks have staged a remarkable comeback this year and are outperforming most major markets since January (Chart 1).

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The reality is that there are numerous positive developments that help explain Chinese stocks’ strong year-to-date performance:

  1. China’s macroeconomic data has beaten expectations. PMIs, GDP growth, and exports have come in better than expected, suggesting growth is more resilient than anticipated (Chart 2).

  2. China has pivoted away from restrictive policies toward a pro-growth and pro-markets stance. Recent challenges resulting from restrictive policies such as Zero Covid, forced property deleveraging, and the regulatory crackdown on internet companies have given way to increasing accommodation. Since the start of the year, significant monetary easing and rate cuts have been accompanied by heavy pro-growth rhetoric. China’s sovereign wealth fund directly intervened in markets, buying ETFs and stocks. And policymakers announced plans for shareholder-friendly reforms including stronger investor protections and more stringent capital markets supervision.

  3. Icy sentiment toward China has started to thaw. A growing number of investors have begun to turn more constructive on Chinese stocks. Managers’ underweight China positions appear to have troughed. And stronger price momentum has driven some net buying by faster-moving quant and hedge funds. Although sentiment is only just beginning to recover off deeply negative levels, sustained outperformance may force managers to add China exposure to limit the drag from their large underweights.