The recent rally in the Chinese stock market was mainly driven by the market's ample liquidity and the rebound may extend to the fourth quarter on investors' expectations of a continued wave of liquidity and prospects for improving earnings, analysts said.

The undervalued large-cap stocks, especially the blue chips such as the bank and resource shares, led the gains of the benchmark Shanghai Composite Index, which has rebounded by 26 percent to hit a near six-month high of 2971.16 points.

Analysts said that the rally benefited from a liquidity wave caused by favorable conditions domestically and the intensified foreign capital inflows attracted by the stronger yuan.

"The loose monetary policies in the developed economies have caused huge inflows of foreign capital into the Chinese market," said Cai Junyi, an analyst at Shanghai Securities.

"The central government's curb on the property market also drove a lot of speculative money into the stock market," he said.

A reversal in global economic policies has unleashed a liquidity wave as China's foreign exchange reserve, the world's largest, surged to a new high of US$2.65 trillion in September.

Although the Chinese central bank has taken steps to rein in the excess liqudity by raising bank's reserve requirement ratio, analysts believe that it will have little real impact on the country's loan growth.

China's credit growth in September surprised the market with commercial banks extending 595.5 billion yuan (US$89.27 billion) in loans, compared with 545.2 billion yuan in August, according to the People's Bank of China.

M2, the broadest measure of money supply, also rose 19 percent in September from a year earlier, the central bank added.

"We expect the rally will be sustainable as domestic liquidity conditions will remain favorable in the coming quarter and the trend of the dollar's devaluation is unlikely to reverse," Cai said.

Foreign investors also turned bullish on the Chinese stock market, which has lagged behind gains in Asia.

China's stocks are in a "solid bull market" and the nation's indexes may rise 20 percent in the next six months, Robert Lutts, president and chief investment officer of the US fund company Cabot Money Management, was quoted by Bloomberg as saying.

Mark Mobius, fund manager at Templeton Asset Management Ltd, said the rally in Chinese stocks is "going to continue" and is "sustainable" as investors remain optimisitc about China's economic growth and companies' improving earnings prospects in the rest of the year.

But some market watchers said that the Shanghai gauge may face resistance at the level of 3000 to 3200 points and the rally may falter if the index fails to stay above that level in order to trigger a real bullish cycle in the long term.

(China Daily October 18, 2010)