Growth Dragons Weekly: Another Fake Rally in China Stocks?
What happened in China this week:
Another Fake Rally in China Stocks?
Alibaba Completes US$5 Billion Notes Issue, Good or Bad
Meituan Revenue Rises 22%, Captures 69% of China’s Delivery Platform Market
Hesai, the Leader in LiDAR, Sees Revenue Surge 21%
Full Truck Alliance Revenue Surges 34%, Profits Skyrocket 81%
#1 Another Fake Rally in China Stocks?
It doesn’t take a genius to sense that the interest in China stocks has waned yet again. After a meteoric rise, they have given back most of their previous gains, reviving the narrative that "China is uninvestible."
Before we delve into our views, it’s essential to analyze the movement patterns of China stocks to understand their behavior. Chinese equities often experience sharp run-ups followed by deep pullbacks. Over the past few years, this pattern has repeated multiple times, as represented by the iShares MSCI China ETF (2801):
Surge #1
Nov 2022 to Feb 2023: +57%
Feb 2023 to Feb 2024: -36%
Surge #2
Feb 2024 to May 2024: +34%
May 2024 to Sep 2024: -15%
Surge #3
Sep 2024 to Oct 2024: +48%
Oct 2024 to Nov 29, 2024: -22%
It’s not merely that China stocks retreat significantly—it’s more about how they surge rapidly in short spans, making these rallies unsustainable. A longer-term trendline drawn from the February 2024 bottom shows a gradual upward slope. We previously covered the technical analysis in Growth Dragons, suggesting that a bull run had begun.
This observation remains valid. Although prices have fallen below the previous peak of approximately HK$20, they remain above the 200-day moving average (MA), which is a bullish indicator. As long as the 200-day MA holds, the bull market in China stocks is intact.
This huge swings in share price an inherent characteristic of the Chinese stock market, driven by limited institutional ownership and heavy retail participation. ETF growth is a step toward reducing volatility, but it will take years before we see significant changes. Investors must accept this volatility as part of the package: quick gains come with equally deep pullbacks.
Another key takeaway is that going contrarian often pays off in the Chinese stock market. When sentiment is overwhelmingly negative, buying opportunities arise. Conversely, during sharp surges, selling to eager buyers can be lucrative. This approach capitalizes on volatility effectively.
Next let’s talk about the fundamentals of the economy.
Investing in China has grown increasingly challenging as the economy transitions into a new growth phase, distinct from its high-growth past. This phase emphasizes restructuring capital rather than heavy investment, mirroring the government’s efforts to address hidden local government debt. This restructuring process aims for slower but more sustainable growth.
China’s M3 money supply reached 227% of GDP in 2023, compared to 100% in the U.S. This indicates a highly active financial system relative to the economy’s size. The abundance of yuan in circulation requires careful management to foster sustainable growth.
China faces oversupply in numerous industries, leading businesses to seek growth abroad. This has resulted in a more diverse and differentiated economy. Expect increased mergers and acquisitions (M&A) to consolidate industries, which will create challenges for investors. In this environment, established "lindy" businesses are likely to thrive, while newer, disruptive firms may struggle.
China’s leadership has highlighted three key growth drivers, often referred to as the “3 main horses”:
Urbanization: Relocating citizens to cities to reduce income inequality.
Domestic Consumption: Higher-end leisure activities, such as marathons, reflect growing consumption.
Export Upgrades: Shifting from cheap goods to advanced manufacturing, with renewable energy and data centers playing pivotal roles.
While overall consumption has been sluggish, spending has increased in specific areas like higher-end leisure activities, particularly marathons. Analysts highlight that when a country’s per capita GDP surpasses $5,000, a cycle of sports consumption typically begins. In China, this marathon boom has grown so prominent that some joke, “中国跑者不够用了” (“China has run out of runners”). Brands like On and Hoka are already capitalizing on this enthusiasm, reflecting how consumption is steadily contributing to economic growth.
China is also moving away from being the global producer of low-cost goods like socks and toys, transforming into an advanced manufacturing hub specializing in high-tech goods and services for export. Industries such as renewable energy and data centers now play leading roles in this evolution. Companies like VNET and GDS, which build and operate data centers, have seen significant growth. Similarly, the Hang Seng China A New Energy Materials Index has shown resilience post-stimulus, emphasizing the renewable energy sector's strength.
In this evolving landscape, investors should prioritize market leaders and businesses aligned with government policies that drive economic recovery. This approach reduces the risk of being whipsawed by market volatility. Although tariffs imposed by the Trump administration have strained U.S.-China trade relations, other countries, such as Mexico, have maintained openness to Chinese investments. Chinese firms are also diversifying globally, with a strong focus on Belt and Road nations, shielding themselves from protectionism while enhancing their global reach.
Tariffs and anticipated tax hikes on Chinese goods have also contributed to the yuan’s depreciation. In response, the People’s Bank of China (PBOC) has acted to stabilize the economy by keeping the medium-term lending rate steady, with 1-year and 5-year loan prime rates unchanged at 3.1% and 3.6%, respectively. These measures aim to maintain short-term stability as China proactively addresses potential challenges from U.S. foreign policies.
The Chinese market’s long-term prospects remain promising despite short-term volatility. Many companies, beyond giants like Alibaba and Tencent, exhibit strong earnings and strategic growth. Investors must look deeper to identify beneficiaries of China’s transitioning economy. Selecting well-positioned market leaders offers the best chance of achieving sustained returns.