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People walk past a screen displaying the Hang Seng stock index outside Hong Kong Exchanges, on July 19, 2022.LAM YIK/Reuters

Chinese stocks are roaring. The Hang Seng Index of Hong Kong-listed stocks has advanced 35 per cent over the past three months. Meanwhile, the MSCI China Index, which tracks a broad range of large and mid-sized Chinese companies, has gained 36 per cent.

Are more gains in store? Quite possibly. Even after its recent gains, the Hang Seng Index is still trading for under nine times its expected earnings over the next year. In comparison with Canada’s S&P/TSX Composite Index or the S&P 500 index in the United States, the Hang Seng looks screamingly cheap.

The trick for investors may be not overstaying their welcome. For all the good news in China, there are also some major caveats, especially when it comes to the longer-term demographic outlook.

To be sure, Chinese stocks are not quite as cheap as they were just a few months ago. Still, analysts at Capital Economics argued this week that the MSCI China Index could gain another 20 per cent over the course of 2023. Researchers at Citigroup, Goldman Sachs and JP Morgan are also bullish about the market’s prospects over the next few months.

Still, it helps to understand what is driving the recent gains.

The biggest single factor is Beijing’s abrupt decision a month ago to end its zero-COVID strategy. The sudden reopening of the country’s vast economy after nearly three years of rotating lockdowns is likely to mean a burst of spending over the next few months as Chinese consumers race to make up for lost time.

Just as encouraging are signs that Beijing is no longer waging an internal war on some of its most innovative companies.

The government cracked down on many of China’s leading tech companies in 2021, perhaps because of fears that the sector’s growing clout could pose a challenge to the primacy of the Communist Party. Policy makers hammered e-commerce giant Alibaba, ride-hailing company Didi and other fast-growing businesses with sudden rule shifts and regulatory changes.

Beijing is now letting up. It has shifted to buying “special management shares” in key online companies such as Alibaba and Tencent. These “golden shares” typically grant the government a board seat and effective veto over decisions it doesn’t like.

Granted, this is still intrusive. However, it’s a much kinder, gentler approach than the sudden swerves and ham-fisted bureaucratic acts of aggression that have prevailed over the past couple of years.

The growing signs of civility in the tech sector add to indications that authorities are eager to get China’s economy moving again.

They are striving to stabilize the country’s troubled property sector by backing off on draconian plans to force heavily leveraged property developers to sharply reduce their borrowing. They also seem to be trying to mend fences with the U.S., at least in some areas.

In one example of their new flexibility, Chinese regulators recently gave U.S. authorities unprecedented access to the work of Chinese auditors. The new transparency alleviated concerns that a couple of hundred Chinese companies could be thrown off U.S. stock exchanges because of concerns about the quality of their accounting.

All of this is potentially good news for foreign investors in China. But here is where the caveats begin.

China’s economy is still under strain. It remains addicted to property speculation. It also remains firmly committed to an export-led development model that is vulnerable if the world slides into a global slowdown this year.

Looking further ahead, the country’s rapidly aging work force is likely to restrain future growth. China acknowledged this week that its population fell last year for the first time since the mass famines of the 1960s.

The population decline last year stemmed from the one-child policy that China introduced in the 1980s. The policy has since been abandoned, but the country’s fertility rate remains stuck far below the level needed to sustain the current population. China will shrink from 1.4 billion people this year to 1.3 billion in 2050, then dip below 800 million by 2100, according to United Nations forecasts.

A shrinking population implies a new economic reality. Instead of being a bottomless repository of cheap labour for the rest of the world, as it was a couple of decades ago, China’s new future will involve supporting a growing number of senior citizens while dealing with the realities of a shrinking domestic market.

Investors may want to keep both the short term and long term in mind when assessing an investment in Chinese stocks.

Over the year ahead, the country’s reopening economy is expected to be a rare bright spot in a gloomy global picture. Xiangrong Yu, an analyst with Citigroup, estimates that China’s economy will grow 5.35 per cent in 2023 while its retail sales surge 11 per cent higher.

Couple those healthy growth numbers with the depressed valuations on Chinese stocks and investors could do quite well over the coming months. But they may want to remember that China has not been kind to investors over the past few years for reasons ranging from a wonky property sector to erratic government policy.

For all the roaring gains of the past few months, the five-year results from Chinese stocks are dismal. Investors who are tempted to bet on the country’s short-term bounce may want to remain wary about longer-term commitments.

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