GO
Loading...

Correction coming for the Shanghai stock rally?

Equities in the U.S. and Europe have traded sideways for much of the last two months culminating in a heavy selloff at the end of last week.

However, over in Asia a stellar rally in the Shanghai Composite has seen the region quietly clock up some modest gains. But rather than seeing this outperformance continue, many analysts are backing the idea that it might be time to sell.

"Chinese shares are definitely looking overdone," Jasper Lawler, a market analyst at online derivatives trading firm CMC Markets told CMBC via email. Lawler concentrates on the FTSE China A50, which tracks Chinese blue-chips fairly closely, and believes that it could "roll over" at current levels.

Read MoreWhy the bulls couldbe back in business

Trading close to 8-month highs, Shanghai's Composite Index saw its largest monthly rise in July since December 2012. Since the middle of June the bourse has risen by 9.7 percent compared with the S&P 500 which has traded flat.

The index has been launched into the "stratosphere," according to Neil Mellor, a senior currency strategist at BNY Mellon. This has been down to a greater confidence in the Chinese economy, he said, with better growth data, more public spending on railways and tax relief for smaller businesses helping to lighten the mood.

shansekala | iStock / 360 | Getty Images

The country's new leadership has made attempts to curb an overheated credit market, step up market reforms and is trying to switch from its traditional export-focused economic model into a consumer-driven one. However, the International Monetary Fund gave the bold changes a lukewarm reception last week by stating that gross domestic product would slow to about 5.5 percent by 2029 even if they were fully implemented. If none of the reforms were implemented it could be closer to 2.5 percent, it predicted.

Companies going bust?

Alastair Winter, the chief economist at global investment bank Daniel Stewart & Co, remains bearish on the Chinese economy and its stock market. Given the market reforms, he believes that the government is toying with the idea of allowing some companies to go bust and warns that any inefficient partly-privatized firms - quoted in Shanghai and in Hong Kong - should be treated with caution.

Read More'China's Apple'knocks Samsung off China top spot

"Some of the best Chinese companies are entrepreneur-founded, typically without much debt and operating in the consumer and related sectors. Many of them have chosen to list in New York and London," he said in a note on Monday.

There are still some bulls ready and willing to talk up the merits of the world's second largest economy, however. Mark Mobius, the executive chairman of Templeton Emerging Markets Group, has been optimistic on China for many years and remains so.

Read MoreChina July services PMI falls to near 9-year low

Erwin Sanft, the head of China & Hong Kong equity research at Standard Chartered, is another seeking to make returns in the emerging market. He told CNBC on Friday that the Shanghai Composite will outperform global markets for the rest of the year, mainly due to a pickup in money supply. His call is for Chinese A-shares - those that trade on Chinese stock exchanges such as the Shanghai Stock Exchange and the Shenzhen Stock Exchange - to see a 20 percent upside before the end of 2014.

The Shanghai Composite retreated by 0.15 percent on Tuesday after data showed the services sector grew at its slowest pace in nearly nine years in July. The services purchasing manager's index (PMI) fell to 50 from June's 15-month high of 53.1. CMC Market's Lawler predicts that this weak data could well tie into a fall in imports on Friday's trade balance data and could prove volatile for Chinese markets.

"That might be the trigger for a correction," he told CNBC.

Contact Asia News

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    To learn more about how we use your information,
    please read our Privacy Policy.
    › Learn More

Asia Video