Almost as quickly as the China stock rally happened, several investment analysts have been swift to point out its weaknesses. “China’s recent rally was not justified by fundamentals,” Citi’s emerging markets strategists said in a note Friday that downgraded China, while upgrading India. The firm is overweight Chinese internet, industrials and technology, but neutral on autos and consumer stocks broadly. Among the sectors, consumer discretionary stocks have the highest expected earnings per share growth this year of about 29%, the Citi report said. After a tepid start to 2024, the MSCI China Index is beating not only emerging markets but the S & P 500 with gains of nearly 11% year-to-date. “Although it looks like a big rally, it’s not broad,” said Ding Wenjie, investment strategist for global capital investment at China Asset Management Co., according to a CNBC translation of her Mandarin-language remarks. “The increase in capital is not as big as we expected,” she said, noting hedge funds rather than long-only funds were doing much of the buying — primarily in Hong Kong-listed consumer discretionary names in the internet tech sector. MSCI China’s top holdings are Hong Kong-listed shares of Tencent and Alibaba , which have both recently ramped up stock buybacks with their extra cash. “Our strategy has always placed great importance on free cash flow,” Ding said, noting a defensive aspect and how recent government capital markets policy has emphasized the ability of companies to buy back stock. Investors in China are increasingly focused free cash flow , an indicator on profitability which reflects how much money a company has generated, excluding operating expenses. The cash can be used to repay creditors or give investors dividends. Such signs of financial health are important in an economy whose growth is slowing after years of rapid expansion, China Merchants Securities pointed out in a webinar on the Wind Information financial platform last week. In an environment of moderating demand, relying on high levels of capital expenditure can no longer generate significant returns, the securities firm said. It’s now focused on finding industry leaders with high free cash flow. Earnings ahead Investors will soon get details on how the best-known names are doing financially. Tencent and Alibaba are due to release quarterly earnings on Tuesday, while Baidu is set to report on Thursday. Hong Kong-based AlphaHill Capital
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