China's bull market risks running out of gas: Raychaudhuri

China's onshore equity markets have significantly outperformed global peers, driven by domestic investor reallocation from property and cash, alongside concentrated gains in technology services and electronic technology sectors. However, the rally faces substantial vulnerabilities, including its narrow breadth, high valuations in leading sectors, and margin financing surpassing 2015 peaks, raising concerns about sustainability. For the bull market to persist, improved corporate fundamentals, stronger domestic demand, and more effective government stimulus are crucial, given declining corporate ROEs and the limited impact of prior policy interventions.

Analysis

China's onshore equity markets, specifically the Shanghai Composite and CSI 300, have posted significant outperformance over U.S. counterparts, rising 9% and 12% respectively since mid-July, fueled primarily by domestic capital. This rotation is driven by households shifting assets from a weakening property market and low-yield deposits, coupled with increased allocations from insurers, who have invested $90 billion in H1 2025 yet still hold only 8.5% of assets in equities. However, the rally's sustainability is questionable due to its narrow breadth. Gains are highly concentrated in a few sectors, notably technology services (+98%) and electronic technology (+81%), with extreme individual stock rallies like Cambricon Technologies' near 500% surge. Significant risks are emerging: valuations in these leading sectors appear stretched, with P/E multiples substantially exceeding forecast EPS growth. Furthermore, outstanding margin financing has surpassed the 2.27 trillion yuan peak seen before the 2015 market crash, signaling elevated leverage risk. Underlying fundamentals remain weak, evidenced by a 15-year decline in corporate return on equity due to margin compression. For the bull market to persist, it requires a material improvement in corporate earnings and domestic demand, yet previous government stimulus has had limited impact, and headwinds from the property sector and lackluster employment remain.

Key Decisions for Investors

• Given that margin financing has surpassed 2015's peak and the rally is narrowly focused, investors should closely monitor leverage levels and market breadth as key indicators of a potential correction and consider trimming exposure to highly concentrated, overvalued tech names.
• The rally's continuation is highly dependent on more effective government stimulus; therefore, closely track policy announcements regarding domestic consumption and resolutions to 'excessive competition,' as the limited impact of past measures makes the market vulnerable to shifts in liquidity.
• For longer-term positions, prioritize companies demonstrating pricing power and capital discipline, as the structural decline in corporate ROE suggests only firms capable of defending margins can justify current valuations and deliver sustainable returns.