While most investors have been fixated on the US stock market, which has been making new highs almost daily over the summer, unnoticed by almost everyone another market on the other side of the world has just hit its highest level in a decade.

The Shanghai Stock Exchange or SSE Composite Index, which is made up largely of domestic Chinese companies with domestic Chinese shareholders, has been on a tear gaining 30% over the past year, and has just hit an historic milestone.

What’s more, analysts and fund managers believe the rally has the makings of a lasting bull run as there are few signs of FOMO (‘fear of missing out’) and short-term volatility in Chinese stocks is generally low.

DIVERGING FROM REALITY?

One of the reasons few people have noticed the rally in Shanghai-listed stocks is the big indices which most firms consider regional benchmarks – such as the MSCI China index or the Hang Seng Index – are nowhere near making 10-year highs.

Another reason is recent Chinese economic data has hardly been supportive of a rally, with retail sales, corporate investment and credit and activity numbers seemingly more representative of a downturn.

Most analysts expect Chinese growth to weaken further in the second half due to the front-loading of exports in the first half and continued lukewarm domestic demand.

So why are stocks ‘diverging from reality’ and making new highs?

One of the reasons is market liquidity, with China’s central bank adding hundreds of billions of yuan of short-term cash through reverse purchase or ‘repo’ operations in order to stabilise the bond market.

The People’s Bank of China recently injected a net CNR 465 billion or $65 billion of liquidity, its third-biggest repo operation this year, as investors desert the bond market over a proposed tax on interest income on new bonds and general concerns over the economy.

That money has to find a home somewhere, and for now it seems Chinese institutional investors are staying close to home, preferring to pile cash into run-of-the-mill domestic stocks rather than whizzy tech names like Tencent (700:HKG), Alibaba (9988:HKG) and Xiaomi (1810:HKG) which make up more than 30% of the Hang Seng and MSCI China indices.

Another reason, says Bank of America’s greater China chief economist Helen Qiao, is these investors are ‘looking through’ the short-term fundamentals, encouraged by the fact US tariffs have been put off yet again.

A third reason, says BNP Paribas’ head of regional equity and derivative strategy Jason Lao, is interest rates have come down a long way in the past year and Chinese households are sitting on more than CNR 160 trillion or $22.3 trillion of savings.

With government bonds yielding 1.6%, and stocks of large Chinese companies yielding 3% to 4%, equities now offer an alternative from an income perspective, adds Lao.

It is also worth pointing out that, in China as in other markets, stocks don’t always move hand in hand with the economy, because investors are constantly looking ahead rather than basing their decisions on current or past trends.

HOW FAR COULD THE RALLY GO?

One of the most interesting features of the rise in Shanghai stocks is how measured it has been – there has been no panic-buying, unlike in previous rallies.

This has encouraged analysts to think there is more to come, and it will also have pleased the Chinese authorities who have been hoping for a ‘slow bull market’ to restore confidence, aid wealth creation and spur domestic consumption.

Chinese consumer confidence fell off a cliff after Covid and is still stuck at levels of mid-2023, according to figures from the OECD.

Yet Shanghai exchange data shows more than 14 million new retail accounts were opened between January and July of this year, which suggests more small investors are becoming aware of the attractions of trading local stocks.

Interviewed on Bloomberg’s The China Show, Hao Hong, managing partner and chief investment officer of Lotus Asset Management, says it is ‘more likely than not’ the rally keeps going.

Most of the money which has flowed into the market so far is institutional, says Hong, and while retail investors have been building up deposits in their accounts, they haven’t yet jumped into the market.

Rising margin debt, rather being seen as a risk, should be seen as ‘encouraging’, argues Hong, adding ‘For the longest time, we haven’t seen this level of risk appetite coming back to the market.’

Whether the rally in Shanghai spreads to other indices is up for debate – stock-focused Chinese ETFs (exchange-traded funds) have seen eight weeks of constant selling up to the middle of August, according to data compiled by Bloomberg.

However, if the rally does spark life into the bigger benchmarks at least foreign investors will have had fair warning.

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