China's Stock Rally Faces Potential "Meaningful Correction," Warn Analysts

According to BofA Securities strategists, China’s stock rally could face a “meaningful correction soon” due to fundamental similarities with the 2015 boom and bust cycle. Despite the recent surge, which has seen the Hang Seng China Enterprises Index (HSCEI) and MSCI China Index rise by at least 30% from their mid-January lows, concerns about sustainability are mounting.

The strategists, led by Winnie Wu, warned in a Monday note that the current rally mirrors the 2015 surge, which ultimately ended in a nearly 50% market drop by February 2016. Despite the recent gains, the HSCEI gauge has yet to recover its pre-crash levels from that period.

Similarities to the 2015 Boom and Bust Cycle

BofA analysts pointed out that there are several fundamental similarities between the current cycle and the one from 10 years ago. Both cycles involve an economic rebalancing and a shift in the policy cycle. However, the strategists cautioned that while this rally appears driven by multiple-expansion, such a rally could be vulnerable to a correction.

Bullish Bets Drive Market Optimism

Despite the cautious outlook, Chinese markets have been experiencing world-beating gains this year, driven by technological advancements from companies like DeepSeek, as well as Beijing’s commitment to economic expansion. This has contributed to a revaluation of Chinese equities, previously overlooked by many global funds. The shifting view on US exceptionalism has also led to increased investor interest in Chinese stocks.

Investor Nervousness and Geopolitical Tensions

However, the strategists, following an investor trip to Shanghai, noted that long-only investors on the mainland are growing increasingly nervous. They are concerned about the lack of improvement in critical areas such as employment, deflation, and credit demand. Additionally, the impact of geopolitical tensions is being largely overlooked, raising further concerns about the market’s stability.

Some investors are also seeing the emergence of bubbles in certain tech sectors, which could further heighten the risks of a correction.

Market Movements and Year-to-Date Gains

On Wednesday, the HSCEI gauge dropped as much as 0.9%, before recovering most of the loss, and the MSCI China gauge followed a similar pattern. Despite the minor dips, the MSCI China index is still up more than 23% for the year, reflecting the strong momentum in Chinese equities.

2025 Outlook: Cautious Optimism

In their 2025 outlook report, released just days before DeepSeek’s technological breakthrough, BofA strategists had expressed optimism, stating that the worst of de-rating and flow-selling for Chinese stocks had likely passed. Although investor conviction remained low, their optimism about the rally persisted. The MSCI China index gained an additional 13% before peaking on October 7.

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