China stocks have surged by nearly 40 percent in just over a month, shrugging off signs of a slowing economy, but valuations look stretched and a violent correction may be on the way, analysts said.
"We are entering into a very volatile consolidation period," Hao Hong, chief strategist at Bank of Communications International, told CNBC. "The markets have risen for more than 300 days without a 10 percent correction, the longest time period in Chinese stock market history," he added.
Shanghai's stock market has been indefatigable this year. Even after the more eight percent sell-off since Tuesday, the Shanghai Composite is up 27.1 percent so far this year, compared with the MSCI Asia ex-Japan's 10.8 percent rise and Emerging Market index's 7.2 percent gain since the beginning of the year.
Even self-confessed China stock "perma bull," Morgan Stanley, is now worried. On Thursday, it cut its rating on China stocks to neutral after keeping an overweight call for more than seven years.
"China's dramatic recent outperformance has driven a deterioration in absolute and relative valuations and a worsening technically overbought situation," the firm said in a note published on Thursday. While its base case is for the Shanghai A-share market to remain stuck in a range, it sees a "clear risk" of a sharp correction.
In an effort to put the recent rally in perspective, analysts have been looking at the last Shanghai bull market back in 2007, a re-rating that dwarfed the current rally, with the Shanghai Composite tapping its all-time high of 6,124 in October of that year.