(Bloomberg) -- Chinese tech shares are benefiting from signs of an improving economy, and will stage another rally when they deliver better earnings, according to an analyst who once questioned the sector’s investability.

The stocks are taking a breather after advancing earlier this year, but there’s room for 20% to 25% more upside as fundamentals such as cost and competition improve, said Alex Yao, co-head of Asia TMT research at JPMorgan Chase & Co. Yao called a bottom for the sector in an April report.

“If the sector is able to grow their earnings at, let’s say, teens or even twenties, over the long run, I think people should reward those corporates for the earnings sustainability,” Yao said in an interview last week.

Tech bellwethers like Tencent Holdings Ltd. have led a rebound in Chinese stocks as Beijing pivoted from a wide regulatory crackdown to focus on policies to bolster the economy. While that has led global funds to lift their weightings, the stocks have given up some gains in the past month as investors want to see improved earnings and more policy support before committing further. 

The Hang Seng Tech Index, which tracks key Chinese tech stocks, rose by 38% from a January low to peak in May. It has since fallen about 8%. 

“The top-down view is that if macro recovers, then the e-commerce names will benefit from the cyclical recovery of consumption,” Yao said. “This time the theme is China macro stabilization.”

Macro Indicators

Investors have been closely watching data coming out of China — including consumption growth, inflation and developments in the property market — for clues on the strength of its economic recovery. “Macro indicators which are showing early indication of a stabilization” have been the main driver of the sector’s rally year to date, and will be a key factor for future share price trends, he said.

China’s growth remains highly uneven. The country’s housing slump deepened in May and industrial output fell short of forecasts. Still, improving consumption and strong exports offer some encouragement for traders. 

Yao surprised the market two years ago when he downgraded 28 firms, including Tencent and Alibaba Group Holding Ltd., saying the sector was not investable amid geopolitical and regulatory risks. While he lifted ratings on some of the stocks just two months later, the term “uninvestable” has since become a closely associated catchphrase.

The analyst now has overweight ratings on stocks including Tencent, Alibaba and Meituan.

To be sure, any rebound in tech shares may be volatile given that sentiment in Chinese stocks remain weak. Investors are also worried about the potential impact of geopolitical risks and a burgeoning price war in China’s nascent artificial intelligence market. 

“What’s most important is for the sector to show consistent and healthy earnings growth,” Yao said. “And if you can deliver that from a fundamental perspective, it’s still a very attractive sector.”

(Updates with Hang Seng Tech Index’s performance in fifth paragraph)

©2024 Bloomberg L.P.