Chinese stocks have been the top performers in the past month. Are they truly making a comeback this time? The question worth trillions.

Since the end of March, the MSCI China index has seen a 10% gain, surpassing other major indexes. This index comprises both domestically traded stocks and Chinese companies listed in Hong Kong and the U.S. Over the same period, the S&P 500 has experienced a 1.3% decline. Chinese stocks have entered bull-market territory as they have experienced a rebound of over 20% from their January lows.

That represents a significant shift following three consecutive years of negative results. However, previous experiences have shown that investors have faced disappointments in the past. The MSCI China index experienced a significant increase of 57% over a three-month period beginning in October 2022, driven by optimism surrounding the reopening of the economy after the Covid pandemic. Unfortunately, much of those gains evaporated as China’s recovery following the pandemic proved to be lackluster.

There are definitely some key factors supporting the rally: China’s macroeconomic data for the last quarter has exceeded expectations, primarily due to a surge in manufacturing activity. Despite the ongoing struggles in the housing market, Beijing has recently indicated its intention to develop fresh strategies to address the surplus of unsold apartments.

In addition, Chinese stocks have experienced a significant decline in value over the past three years, making them appear to be priced attractively. According to FactSet, the Hang Seng China Enterprises index, which measures Chinese companies listed in Hong Kong, is currently trading at a forward earnings multiple of 8.9, even after the recent rally. This is lower than the 10-year average of 11.3 times. Internet giants Alibaba and Tencent have recently increased their buybacks, providing valuable support to their stocks.

Chinese stocks have also seen positive effects from the instability in other markets. The recent increase in interest rates in the U.S. had a significant impact on certain trades in the market, such as chip stocks, which were already overcrowded. There has been a decrease in the amount of money flowing out of China into other markets. Despite their benchmarks, institutional investors have been gradually increasing their exposure to China, indicating a shift in their investment strategy. According to Morgan Stanley, Asia ex-Japan funds and emerging market funds have recently decreased their underweight positions in China by 0.8 to 1 percentage point.

However, corporate profits continue to show signs of weakness. The housing market decline continues to impact domestic demand, while decreasing producer prices are putting pressure on manufacturers’ profits. According to Goldman Sachs, analysts have revised down their consensus earnings-per-share estimates for this year by 7% for stocks in the MSCI China index. However, there have been some positive earnings upgrades in certain sectors, such as internet companies.

The attractive valuations and the strong momentum of fund flows are likely to sustain the Chinese market in the near future. However, for a rally to be more sustainable, it will require a recovery in earnings growth.