Is a bubble in Chinese stocks being inflated?

A surge in China’s A-shares and, more recently, Hong Kong’s H-shares has reignited a sense of excitement about the China equity story after five years of lacklustre performance by both markets versus global equities. However, many investors are increasingly concerned about whether this move in the markets is sustainable.

The rally in A-shares started in the third quarter of last year, seemingly due to local investors’ expectations for policy easing and a shift in investment appetite away from the slowing Chinese property market into out-of-favour local equities. The launch of the Shanghai-Hong Kong Stock Connect in November 2014 provided a further sentiment boost with expectations of foreign fund flows to the A-share market.

The bullish sentiment and liquidity onshore then started to spill over into the Hong Kong market from early April. This was mainly driven by both a change in the regulation allowing domestic mutual funds to access Connect and investors’ focus on the widening discount of H-shares versus their A-share equivalents. Trading volumes in the Hong Kong market have reached new highs and the broader Hang Seng Index has broken out of its post-crisis trading range in the last month.

How long will this upward move last? What could be a trigger for the bubble to burst? And how are our portfolios positioned against this market backdrop? We attempt to address these questions in our full analysis found below.

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