Chinese Stocks Have Rallied. Why They’re Not Done Yet.

Prices on display at the Shanghai Stock Exchange in April. (Hector Retamal / AFP / Getty Images)

Key Points

• Chinese equities have not only outperformed U.S. equities by roughly two to one since early 2024, they offer better value than American stocks.
• China’s government is implementing policies to reduce overcapacity and competition, making its stock market more investable.
• China’s central bank has ample room to support the economy, potentially channeling funds into domestic stocks, unlike other major economies.

It is often said that “it’s different this time” are the four most expensive words in investing. Yet there is also the Chinese proverb ‘the beginning of all things is difficult.’

The question is which is more applicable to China’s stock market. It comes up because while investors don’t have much exposure to Chinese equities, the market is getting harder to ignore.

Investors have tended to steer clear because the stocks are underrepresented in global equity indexes and because the companies can be opaque about their operations. Their fortunes can change depending on which way the wind blows in Beijing, given the government’s involvement in the private sector.

Yet as Louis-Vincent Gave, founder of the Hong Kong-based research and financial service firm Gavekal Research, highlights, the Hong Kong, Shanghai, and Shenzhen exchanges together give Chinese stocks the world’s second-largest market capitalization. Moreover, since Beijing began intervening to support the economy at the start of 2024, Chinese equities have outperformed U.S. equities by roughly two to one, while still offering more tempting value than richly priced American stocks.

While many investors remain skeptical—China’s stock market is no stranger to boom-and-bust cycles—Gave argues that there are reasons to believe that things are changing for the better.

He points to a government campaign launched earlier this year and aimed at reducing overcapacity and intense competition among domestic companies via regulation and policies like production caps.

Now, Gave says, China is becoming truly investable in a way it wasn’t before. While investors were once rightly concerned that Beijing would sacrifice individual companies for the greater good, that Chinese firms could be delisted from foreign markets or feel other strain from sanctions, and that Chinese companies prioritize market share over returns on invested capital, things are changing.

Gave writes that “policymakers have clearly decided that supporting higher asset prices now serves the public interest,” while Beijing’s willingness to play hardball with the U.S. using its dominance in rare-earth metals shows that the U.S. doesn’t hold all the cards when it comes to trade negotiations.

And although China may remain focused to a degree on market share over profit, investors in the U.S. are at least familiar with that approach. American big tech companies are chasing dominance in artificial intelligence at any price.

In addition, despite the nation’s real estate bust, Gave argues that China isn’t likely to face a “lost decade,” as Japan did in the 1990s following the collapse of an asset-price bubble. The economic situation mirrors that in the U.S. following the 2008-2009 financial crisis, when the economic backdrop was incredibly supportive of equities, he says.

And China is the only major economy not grappling with inflation, giving its central bank plenty of cushion to put money to work in the economy, most likely largely in domestic stocks.

As the DeepSeek scare at the start of the year makes clear, investors also shouldn’t discount China’s role in the AI revolution. “Markets currently assume that US companies will dominate AI just as they did the smartphone era, and that it will be equally profitable for them,” writes Gave. “That may hold true if computing power proves the key bottleneck. But if the real constraint is access to cheap, abundant electricity, China could emerge as a far bigger player than markets now anticipate.”

That said, plenty of these positive changes could also reverse, so Gave thinks caution is still warranted.

For now, though, the situation still looks supportive, given his belief that “investing in equities is about determining whether there is ‘more money than fools’ (a buy signal) or ‘more fools than money’ (when valuations risk outrunning liquidity).”

He says comparing market capitalization to broad money supply can help to make that call. “Today, the US sits at one extreme—and China at the other,” Gave writes. “It thus would likely not take too much of a shift from domestic bank deposits to Chinese equities for the unfolding bull market to keep going.”

The beginning of all things may be difficult, but the path to further gains looks less arduous.

Write to Teresa Rivas at teresa.rivas@barrons.com