Why China's Growth Data Failed to Spur Rally in Stocks

News that growth in China has continued to hold up brought relief to Asian markets, but stocks failed to rally as hopes for more aggressive stimulus by Chinese policymakers to bolster the world's second largest economy faded.

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China's economy grew 7.6 percent in the April-June quarter from a year earlier, the National Bureau of Statistics said, the slowest pace since the January-March quarter of 2009. In the first quarter of the year, China's economy grew 8.1 per cent from a year earlier.

The Shanghai Composite , which edged higher following the release of the data, slipped back into negative territory by midday. Japan's Nikkei 225 and Australia's ASX-200, which rose further following the data, also pared back the gains in the afternoon session.

“The initial bounce in stocks was a reflection of relief among investors that growth in China is continuing to hold up,” Darius Kowalczyk, Senior Economist & Strategist at Credit Agricole told CNBC.

However, equity market gains were capped by a fall in expectations for aggressive stimulus by Chinese policymakers, Kowalczyk said.

“Growth data suggests the bottom is behind us. This means there is less need for desperate to stimulus for policy measures,” said Kowalczyk, who forecast growth of 7.5 percent in the second quarter.

Diane Lin, Fund Manager at Pengana Capital agrees, adding that the biggest concern at the moment is a risk of a delayed response from the Chinese government that could lead to a further weakening of the economy and earnings.

Other economic indicators released alongside the GDP data pointed to a pick-up in growth. China’s fixed asset investment, which is watched as an indicator of construction activity, grew 20.4 percent in the year to June, compared to expectations for a rise of 20 percent.

Kowalczyk says that while the People’s Bank of China (PBoC) is unlikely to cut interest rates further this year, he forecasts the central bank will engage in further reserve ratio requirement cuts as well as fiscal measures.

China’s central bank last week cut interest rates for the second time in two months to bolster its economy.

Kowalczyk believes policies implemented will suffice to bring up economic activity in the second-half, adding that his target is for 8 percent growth in 2012.

“This is good news for Chinese equities in the medium-term, as well as for the yuan, which we expect to appreciate in the second-half.”

For investors looking to gain exposure to mainland equities, Lin recommends picking companies that could provide long-term growth.

“We believe healthcare and life insurance companies are the new consumer plays for China,” she said, adding that the two sectors are minimally impacted by earnings compression.

By CNBC’s Ansuya Harjani