Another round of crash ahead？China stocks market to watch out for

The excellent performance of China's stock market in June has made some Wall Street strategists optimistic. But if recent history serves as a guide, unless fundamentals improve, it could prove to be another short-lived rally.

The MSCI China index is up about 8% since plunging into a bear market last month, outpacing the composite index of other Asian stocks. Goldman Sachs said the tactical trading window for Chinese equities was "open again", while Nomura said expectations of further stimulus from the property sector could help stabilize the market.

Still, short-selling volumes in Hong Kong stocks have remained high in recent weeks, suggesting gains may have been driven by fast-money investors covering up bearish bets, as most long-only funds remain heavily underweight in Chinese equities. Stocks plunged again Tuesday as markets were disappointed by a relatively modest cut in lending rates by Chinese banks, with potential catalysts including Blinken's China trip and a State Council meeting largely irrelevant to investors.

"As far as we know, it is mainly short covering at present," said Tan Wenhan, head of research in Greater China of UOB Kay Hian (Hong Kong). He said that "the recovery will be gradual and consumer confidence may remain fragile in the short term" because the government may not take large-scale stimulus measures.

Facts have proved that every rise in China's stock market in the past two years has been short-lived.The last two major rallies, each lasting only about three months, have been fueled by hopes of economic recovery and Covid reopening, respectively.

However, many pessimism about China's economic recovery and geopolitical concerns between China and the United States have been digested. Valuations have fallen to convincing levels, with the forward P/E of the MSCI China Index at just 10.6 times, suggesting that there may be a bargain-hunting opportunity.

Wendy Liu, chief Asia and China equity strategist at JPMorgan Chase, wrote in a report that some regional and global funds may begin to reduce their significant holdings in China. But she expects inventories to fluctuate within a narrow range in the third quarter because "continued destocking, weak demand, debt restructuring and projected cuts may increase downward pressure."

Ultimately, the sustainability of this rebound will depend on the upcoming macro data and "whether policy makers can fulfill their promises to boost growth and earnings expectations in the coming months," said Ben Luk, senior multi-asset strategist at State Street Global Markets.

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