Time to Get Off the China Stocks Train?

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Chinese shares are having their day in the sun, with the benchmark Shanghai stock index trading at an eight-month high on Thursday. The rally, however, may be close to running its course, some analysts say.

Amid signs of a rebound in China's economy, the Shanghai Composite has jumped about 22 percent from a 4-year low hit in early December. That's better than an 18 percent gain in the same period for Japan's booming Nikkei stock index, which has had reasons of its own to zoom higher. Chinese shares have also outperformed the MSCI's pan-Asia index, which has gained almost 6 percent since early December.

(Read More: Why It's Time to Underweight Japan)

Still, after gaining ground fast and in a short space of time, Chinese shares now look more likely to trade sideways, said Phillip Chan, a director at Shenyin Wanguo Securities in Hong Kong.

"We're reasonably upbeat about Chinese stocks, although as a house we're not looking for huge upside on the Shanghai Comp," he said. "It's had a strong run up last month and this month, so it's almost hit the target we set around 2,400."

The Chinese stock index rose to 2,385 on Thursday, its highest level since early June last year.

Chan says China's economic performance this year is unlikely to be as strong as some in the market expect - a reason why further strong gains in Chinese shares may be limited.

The Chinese economy, the world's second largest, grew 7.9 percent in the fourth quarter of last year from a year earlier, recovering after seven consecutive quarters of slowdown. The signs of a recovery have helped boost upbeat sentiment in the global financial markets.

(Read More: This Is What Could Knock Euphoric Global Markets)

"We're not looking for huge growth in the economy and we are on the conservative side," said Chan, adding: "The recovery isn't that strong."

Economy Watch

That's a view that Nomura's China Equity Strategist Wendy Liu shares.

She says there might be room for Chinese stocks to edge a little bit higher but the rally could start to unwind as signs of slower economic growth and higher inflation come through.

"We think there will be a correction going into mid-year on a reduced cyclical growth outlook and heightened inflation. So, we've had the rally and we may have a little bit more, but now it may be stalling," Liu said.

Nomura forecasts Chinese economic growth at 7.7 percent this year, below the market consensus forecast of about 8.1 percent; and inflation of 3.5 percent, higher than the consensus forecast of about 3.1 percent.

Liu says Nomura set a 2013 target for the MSCI China Index last July of 54 to 69. The MSCI China Index is currently trading around 65.95.

"The MSCI China index has had a good run. We are mindful that the market will give up some of its gains and the trigger for that could be slower growth and higher inflation but that's probably a Q2 event," she said.

The Shanghai Composite is trading at a price-to-earnings ratio of about 12, up from about 10 late last year, which was the cheapest since 2008. That compares with Hong Kong's Hang Seng stock index, also trading at about 12.

Other analysts anticipate further strong gains.

"I don't think China is out of the woods yet, but if (stocks in) Greece can rally 100 percent from its lows, then China can rally 30-40 percent from its lows," Marc Faber, a renowned market bear, told CNBC.

(Read More: Goldman on China Stocks: Why We'll Be Right This Time )


Peter Elston, Head of Asia Pacific Strategy & Asset Allocation at Aberdeen Asset Management told CNBC that despite the recent gains in Shanghai stocks, accounting scandals at Chinese companies remained a concern and the best way to gain exposure to the Chinese market was through Hong Kong shares.

In recent years, a string of Chinese companies trading in the U.S. have been delisted because of allegations or accounting probes. U.S. machinery firm Caterpillar this week unveiled a much lower than expected profit due to a charge connected with an accounting fraud at a Chinese subsidiary.

"Yes, at the moment you are seeing a spurt in the Chinese stock market, but we think the best way to invest in China is through high-quality companies, Hong Kong companies that do business in China, where as an investor you know you are going to be looked after," Elston said.

"We have a big underweight position in China and a big overweight (position) in Hong Kong companies that we've held for many years such as the conglomerates and property companies that have been doing business on the mainland," he added.

- By CNBC's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC