Is the China A-Share Bull Market Legitimate or a Policy-Driven Bubble?

The recent 29% rally in China's A-Share market has sparked a heated debate: Is this a genuine recovery driven by structural reforms and improved fundamentals, or a short-term policy-induced bubble fueled by liquidity injections and fiscal stimulus? To answer this, we must dissect the interplay between liquidity inflows, policy credibility, and economic fundamentals.

Liquidity Inflows: A Double-Edged Sword

China's M2 money supply, a broad measure of liquidity, surged to 329.94 trillion CNY in July 2025, up 8.78% year-on-year. This expansion, driven by both monetary easing and fiscal stimulus (e.g., infrastructure spending), has created a favorable environment for asset markets. However, the July 2025 credit contraction—the first in 20 years—casts doubt on the sustainability of this liquidity. New yuan loans fell by 50 billion CNY, signaling weak domestic demand and a fragile transmission mechanism from monetary policy to the real economy.

While M2 growth historically correlates with A-Share liquidity, the relationship is not linear. Studies show that firms often respond to M2 expansion with negative investment outcomes, particularly when liquidity is channeled through government-directed projects. For example, the 2025 Action Plan on Stabilizing Foreign Investment, which removed restrictions on foreign equity investments and expanded the QFLP program, has attracted short-term capital. Yet, this inflow may not offset the broader economic malaise, as retail sales growth slowed to 3.7% in July 2025, the weakest in over a year.

Policy Credibility: A Question of Long-Term Commitment

The Chinese government's interventionist approach—from rate cuts to trillion-yuan bank capital injections—has been instrumental in propping up the A-Share market. However, the credibility of these policies remains questionable. For instance, while the PBOC pledged to maintain a “reasonable pace of price growth,” its January-July 2025 credit data revealed a net reduction in July, undermining confidence in its ability to stimulate demand.

Moreover, the government's reliance on short-term fiscal measures (e.g., 1 trillion CNY bank capital injections) contrasts with the scale of China's structural challenges. The debt-to-GDP ratio now exceeds 300%, and the property sector's collapse has left a void in investment and consumption. Without deeper reforms—such as broad-based tax cuts, private sector support, or a shift away from overcapacity-driven growth—the current rally risks being a temporary illusion.

Economic Fundamentals: A Tenuous Foundation

The A-Share market's performance has diverged sharply from underlying economic conditions. While the Shanghai Composite rose 30% in 12 months, key indicators remain dire:
- Producer prices have contracted for 34 consecutive months, signaling deflationary pressures.
- Fixed asset investment fell by 5.2% year-on-year in July 2025, the largest drop in over two decades.
- House prices continue to decline, with sales and construction down 50–70% over three years.

These trends suggest that the A-Share rally is more a function of policy optimism than genuine economic momentum. For example, state-owned banks trade at below 5x forward earnings, while the MSCI China index trades at a 13x earnings discount to global peers. Such valuations reflect skepticism about the government's ability to address systemic risks, including debt deflation and weak consumer demand.

Investment Implications: Caution Amid Optimism

For investors, the key question is whether to bet on the A-Share rally or hedge against a potential reversal. Here's a balanced approach:
1. Monitor Policy Execution: The success of the 2025 Action Plan hinges on its implementation. If the government follows through with structural reforms (e.g., easing foreign ownership caps, supporting private enterprises), the A-Share market could stabilize.
2. Assess Sectoral Resilience: Defensive sectors (e.g., utilities, consumer staples) and state-owned enterprises (SOEs) are better positioned to weather policy-driven cycles. Conversely, cyclical sectors like real estate and manufacturing remain vulnerable.
3. Diversify Exposure: Given the risks of a policy-driven bubble, investors should diversify across global markets and consider hedging against currency and geopolitical risks.

Conclusion: A Delicate Balance

The China A-Share bull market is neither entirely legitimate nor a pure bubble. It reflects a policy-driven rebound in a fragile economy, supported by liquidity injections and regulatory reforms. However, without addressing structural imbalances—such as overleveraging, weak consumption, and property sector collapse—the rally's sustainability remains uncertain. For now, investors should adopt a cautious, selective approach, prioritizing quality over momentum and closely watching for signs of policy fatigue or economic deterioration.