(Bloomberg) -- All the signs are pointing to a revival of Chinese stocks.

Benchmarks in Hong Kong are having their best week in years. Foreign fund purchases of Chinese stocks through a trading link hit a record 22.4 billion yuan ($3 billion) on Friday. UBS Group AG has turned overweight, while others say there’s growing interest in one of last year’s worst-performers.

Improvement in China’s economy and earnings growth are driving what some money managers are calling cautious optimism about the world’s second-biggest stock market after years of underperformance. There are also signs that global funds are rebalancing away from countries like the US where record rallies have sent valuations surging.

“We have been hearing from brokers that both hedge funds and long-only interest in China stocks have recently increased,” said Ken Wong, an Asian Equity Portfolio Specialist at Eastspring Investments Hong Kong Ltd. “With US interest-rate levels expected to remain at elevated levels for a longer period, there seems to be some asset reallocation to buy undervalued stocks and hence the recent change in sentiment.”

All three main gauges in Hong Kong have rallied hard this week, with the Hang Seng Tech Index leading with a 13% gain. The city’s benchmark gauge has advanced near 9% this week, its best performance since late 2011. Meanwhile, the Hang Seng China Enterprises Index, which tracks Chinese companies, is also having its biggest weekly gain since 2015.

Analysts point to a myriad of reasons for the sudden inflows. 

BNP Paribas SA said Chinese investors are rushing into Hong Kong to diversify out of a weakening yuan. Others are pointing to a pledge by China’s market regulator to improve fund flows into the financial center as well as encourage more companies to list there.

Meanwhile, Chinese investors have bought more than HK$74 billion ($9.5 billion) worth of Hong Kong stocks via the southbound trading links in April, according to data compiled by Bloomberg. 

Whatever the reasons, Hong Kong gauges — which are much easier to access for foreign investors than mainland stocks — are the best performers globally this week.

“I think the phrase that everyone uses is cautiously optimistic,” said James Kenney, senior investment manager at Pictet Asset Management based in Hong Kong. “The starting position of cheap valuation, low ownership and government support is a positive one. The macro is still going to be tough.”

Even though Chinese stocks bottomed out in January after months of selloff, there was continued skepticism over their recovery given how state-related funds had supported the market. By one calculation China’s sovereign wealth fund likely bought at least $43 billion of onshore exchange-traded funds in the first quarter.

Investors turned cautious in March as they tried to determine if the gains were sustainable.

The surge in Chinese tech firms may well suggest risk-taking is back. The Hang Seng Tech Index is close to erasing its losses for 2024. The gauge capped an unprecedented third straight annual loss in 2023 and is trading at less than 15 times its one-year forward estimated earnings, compared with a multiple of 24 times for the Nasdaq 100.

Tech bellwether Tencent Holdings Ltd.’s shares have surged almost 15% this month, outperforming a gauge tracking the Magnificent Seven after an earlier-than-expected blockbuster game debut. 

The stock gains “should be seen in the context of three years of underperformance which has left China cheap and under-owned,” said Kieran Calder, head of equity research for Asia at Union Bancaire Privee in Singapore. “This highlights the main risk for China bears this year: valuation and sentiment are so weak that just a little good news (or lack of bad news) can have an outsized market impact.”

--With assistance from Abhishek Vishnoi, Mengchen Lu, Shikhar Balwani, Sangmi Cha, Ernest Tsang and April Ma.

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