Eliza Wong
Veteran Analyst Sounds Caution Bell on China’s Equity Rally
Ahead of the 2025 Phoenix Bay Area Financial Forum, former chief economist Li Daxiao (李大霄) delivered a timely warning to market participants. The prominent analyst observed that the Shanghai Composite Index has surged from 2,689 to 3,900 points within just twelve months, representing a remarkable 45% appreciation that demands strategic consideration.
This rapid appreciation presents both opportunities and challenges for global investors tracking Chinese equities. Market technicians and fundamental analysts alike are now questioning whether current valuation levels can sustain without periodic consolidation.
The Necessity of Adjusting the Pace of Gains
Li Daxiao’s central thesis revolves around the concept of adjusting the pace of gains to ensure sustainable market development. The veteran market observer believes that excessive velocity in equity appreciation often precedes painful corrections that damage investor confidence.
Historical Precedents for Pace Management
China’s equity markets have experienced similar cycles throughout their development. The 2006-2007 bull market saw the SSE Composite rise from 1,160 to 6,124 points before collapsing dramatically. More recently, the 2014-2015 rally witnessed a 150% surge followed by a 40% correction within months.
– 2007 Bubble: 12-month gain of 428% followed by 72% decline
– 2015 Correction: 150% advance preceding 40% collapse
– 2020 Recovery: 35% pandemic rebound with minimal pullbacks
Technical Indicators Suggest Overheating Conditions
Multiple technical analysis tools currently flash warning signals that support Li’s assessment. The relative strength index (RSI) for major indices has consistently traded above 70 since November 2024, indicating potentially overbought conditions.
Valuation Metrics and Comparative Analysis
The median price-to-earnings ratio for Shanghai Composite constituents now stands at 18.7, approximately 22% above the 5-year average of 15.3. While not excessively expensive by historical standards, this premium warrants attention when combined with the velocity of recent gains.
Small and mid-cap stocks show even more stretched valuations, with the ChiNext Index trading at 37.8 times earnings compared to its 28.4 historical average. This divergence suggests selective overheating rather than broad market excess.
Regulatory Perspective on Market Stability
The China Securities Regulatory Commission (CSRC, 中国证券监督管理委员会) has maintained a cautiously optimistic stance throughout the rally. Officials have emphasized the importance of “stable and healthy market development” in recent public statements.
Regulators face the delicate balancing act of encouraging capital market development while preventing asset bubbles. The CSRC’s measured approach to new equity issuance and corporate fundraising suggests awareness of potential overheating risks.
Institutional Flow Patterns and Market Impact
Northbound capital flows through Stock Connect programs have shown increased volatility in recent weeks. Daily net inflows reached record highs of ¥18.2 billion ($2.5 billion) in January before moderating to approximately ¥6.5 billion ($900 million) in recent sessions.
This moderation in foreign institutional buying coincides with increased domestic mutual fund redemptions, suggesting sophisticated investors are indeed adjusting the pace of gains through portfolio rebalancing.
Sector Rotation as Natural Pace Adjustment Mechanism
Market participants have observed healthy sector rotation throughout the rally, providing natural mechanisms for adjusting the pace of gains. Early leaders including technology and consumer discretionary stocks have given way to financials and industrials in recent months.
Energy and Infrastructure Taking Leadership
The China Securities Index (CSI) 300 Energy Sub-index has gained 28% year-to-date compared to 22% for the broader benchmark. This outperformance reflects shifting market leadership toward more reasonably valued segments.
– Technology sector: P/E 42.3, +18% YTD
– Financial sector: P/E 8.2, +26% YTD
– Industrial sector: P/E 16.4, +24% YTD
Forward-Looking Investment Implications
Investors should consider rebalancing strategies that incorporate Li Daxiao’s warnings about adjusting the pace of gains. Portfolio diversification across market caps and sectors becomes increasingly important during periods of rapid appreciation.
International allocators might consider increasing exposure to Hong Kong-listed H-shares, which trade at significant discounts to their A-share counterparts. The Hang Seng China Enterprises Index trades at just 8.7 times earnings compared to 18.7 for Shanghai Composite.
Options Strategies for Volatility Management
Sophisticated investors are increasingly employing options strategies to hedge against potential corrections while maintaining equity exposure. Put option volumes on CSI 300 ETF options have increased 37% month-over-month, indicating growing hedging activity.
The volatility skew between call and put options has widened significantly, with 3-month 90% put options trading at 4.2 volatility points above comparable calls. This pricing suggests professional traders are paying premiums for downside protection.
Strategic Positioning for Institutional Portfolios
Fund managers should consider gradually taking profits in extended positions while maintaining core exposure to China’s long-term growth story. The concept of adjusting the pace of gains applies not only to market indices but to individual portfolio management decisions.
Increasing allocations to defensive sectors including utilities and consumer staples might provide stability during potential consolidation phases. These sectors typically demonstrate lower volatility while still participating in broader economic growth.
Currency Hedging Considerations
International investors must consider RMB (人民币) exposure management alongside equity positioning. The People’s Bank of China (PBOC, 中国人民银行) has maintained relative currency stability, but equity market volatility often correlates with currency movements.
– Unhedged exposure: Benefits from RMB appreciation
– Fully hedged: Eliminates currency risk but adds cost
– Partially hedged: Balances risk and opportunity
Synthesizing Market Intelligence for Decision Making
Li Daxiao’s commentary provides valuable perspective from an experienced market participant who has witnessed multiple cycles. While not predicting an immediate correction, his emphasis on adjusting the pace of gains deserves consideration in investment committee discussions.
The remarkable 45% advance in Chinese equities reflects genuine fundamental improvements including corporate earnings growth, economic recovery, and regulatory support. However, sustainable bull markets typically advance through alternating phases of appreciation and consolidation.
Prudent investors might consider gradually rebalancing toward reasonably valued segments while maintaining strategic allocations to China’s equity markets. Monitoring technical indicators and fundamental metrics will provide guidance for appropriate positioning adjustments as market conditions evolve.
Review your China equity allocations considering both return potential and risk management objectives. Consult with investment professionals to develop strategies that incorporate appropriate mechanisms for adjusting the pace of gains in your portfolio.
