Assessing the Sustainability of China’s Stock Rally Amid Economic Weakness and Options Market Skepticism

China’s stock market has surged in 2025, with the Shanghai Composite up 35.74% year-to-date, fueled by aggressive policy stimulus and a pivot toward domestic consumption [5]. Yet beneath this optimism lies a fragile foundation: a slowing economy, deflationary pressures, and a surge in bearish sentiment in the options market. The iShares China Large-Cap ETF (FXI) now trades with a 30-day put/call ratio of 1.25, a level historically associated with market fear and potential reversals [4]. This divergence between asset prices and fundamentals raises critical questions about the rally’s sustainability—and the risks for investors who may be overestimating the resilience of China’s economic rebalancing.

The Illusion of Strength in GDP

China’s Q2 2025 GDP growth of 5.2% masks structural weaknesses. While the service sector—particularly IT and financial services—has offset declines in manufacturing and construction, the headline figure is inflated by deflationary base effects and a drop in quarter-on-quarter growth to 1.1% [1]. Industrial overcapacity, especially in steel and property, remains unresolved, and retail sales growth has slowed to 3.7% year-on-year in July 2025, missing analyst forecasts [3]. These trends suggest a reliance on short-term stimulus rather than a durable shift in consumer demand.

Options Market Skepticism as a Contrarian Signal

The options market tells a different story. A put/call ratio above 1.2, as seen in FXI, typically signals extreme bearishness and is often a contrarian indicator of market bottoms [4]. Historical precedents, such as the 2015 China stock crash, show that elevated PCR levels can precede sharp corrections. In 2015, the S&P 500’s PCR spiked to 3.77 amid fears of China’s economic slowdown, foreshadowing a 32% collapse in the Shanghai Composite [5]. While the current PCR of 1.25 is lower than 2015’s extremes, it still reflects significant pessimism, particularly in sectors like property, where short interest has surged to over 10% for some developers [6].

Volatility and the Shadow of Policy Interventions

China’s stock volatility index stands at 18.24 as of August 2025, a sharp drop from the 33.49 level in early 2022 [5]. This decline suggests reduced fear, but it also highlights the government’s role in managing market sentiment. During the 2020 pandemic, for example, regulators suspended the volatility index’s publication to calm panic [3]. Today, the market’s calmness may be artificial, propped up by state-backed liquidity injections rather than organic demand. The 2024-2025 rally, driven by interest rate cuts and fiscal stimulus, mirrors 2015’s speculative surge but with lower leverage—a key difference [4]. However, the absence of a clear path to rebalancing the economy toward consumption remains a vulnerability.

Risk Management in a Fragile Environment

For investors, the lesson is clear: the current rally is a policy-driven rebound, not a structural turnaround. While the government’s tools—such as targeted support for green tech and AI—offer short-term tailwinds, the risks of overcapacity and deflation persist. A contrarian approach would involve hedging against downside scenarios, particularly in sectors with high short interest (e.g., property developers) and monitoring PCR levels as a leading indicator. Historically, PCR spikes above 1.2 have often preceded corrections, even if the timing is uncertain [4].

Conclusion

China’s stock market is at a crossroads. The government’s stimulus has bought time, but it has not solved the deeper issues of overreliance on exports and industrial excess. The options market’s skepticism, as reflected in elevated PCR levels, serves as a cautionary signal. For investors, the key is to balance optimism about policy-driven gains with a realistic assessment of the economic undercurrents. In a market where sentiment can shift overnight, prudence—and a willingness to question the narrative—is the best risk management strategy.

Source:
[1] Solid GDP growth in Q2 masks China's challenges [https://merics.org/en/tracker/solid-gdp-growth-q2-masks-chinas-challenges]
[2] China Economic Update Report, Q2 2025 [https://arc-group.com/report/china-economic-update-report-q2-2025/]
[3] China's growth stumbles in July as retail sales, industrial ... [https://www.cnbc.com/2025/08/15/chinas-growth-stumbles-in-july-as-weak-demand-industrial-capacity-curbs-weigh.html]
[4] iShares China Large-Cap ETF (FXI) - Put-Call Ratio (Open Interest) [https://www.alphaquery.com/stock/FXI/volatility-option-statistics/30-day/put-call-ratio-oi]
[5] China Shanghai Composite Stock Market Index - Quote [https://tradingeconomics.com/china/stock-market]
[6] Prime property shorts in China [https://www.spglobal.com/marketintelligence/en/mi/research-analysis/15062016-equities-prime-property-shorts-in-china.html]