(Bloomberg) -- US short sellers are betting that the rally in Chinese stocks has run its course and capital will rotate back to emerging markets outside China.

Bearish wagers against BlackRock Inc.’s iShares China Large-Cap Exchange Traded Fund, which buys Hong Kong equities such as Tencent Holdings Ltd. and Meituan, jumped last week to the highest level since October 2020, according to S&P Global data. Similar positions against an iShares ETF that invests in both Hong Kong and mainland stocks saw the biggest short interest since February 2021.

At the same time, traders cut down their positions against the iShares MSCI Emerging Markets ex-China ETF to near zero, showing the least bearishness in 15 months. Short traders borrow an asset whose price they expect to fall and then sell it on the expectation of pocketing a price difference when they give it back to the lender. An increase in short interest suggests stronger expectations of price drops.

Chinese and Hong Kong stocks have soared since January, adding $1.6 trillion and $1.2 trillion in market value, respectively, after Beijing announced a slew of supportive measures including lower borrowing costs and a $728 billion stimulus. But the results have been patchy: China’s industrial activity and employment are improving, while consumer demand remains weak and the housing sector continues to shrink. Investors remain wary of sudden regulatory crackdowns, a key risk from Beijing’s market policies since 2015.

The Hang Seng China Enterprises Index has handed investors a 37% return in dollar terms since Jan. 22, while the CSI 300 gauge of mainland stocks shows a 14% gain. While ex-China EM stocks have also advanced in this period, they have underperformed, with the benchmark index for the segment rising 9.6%.

That has prompted global investors to pour money into Chinese equities. The country recorded the biggest US ETF inflows among emerging-market peers for the week ended May 17, with $488 million of new deposits. 

Now, short sellers are betting that the rally will soon run out of steam, amid worsening capital outflows and pressure on the yuan. 

Segments of Chinese stocks remain cheap and can continue to gain from value buyers, according to Mark Matthews, Singapore-based head of Asia research at Bank Julius Baer. He cites a rebound in property stocks as China doubled relaxed mortgage rules and urged local governments to buy unsold homes. 

“It is still a very cheap market,” Matthews said. “For example, Hong Kong property stocks trade at a 62% discount to their net asset value, compared to a long term average discount of 27%. The government pledging to remove excess housing inventory is very helpful for the economy and household sentiment.”

(Updates stock returns in fifth paragraph. An earlier version of the story was corrected to fix the spelling of index names)

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