The recent surge in the Chinese banking sector has captured the attention of investors and analysts alikeParticularly noteworthy is the remarkable performance of the country’s four major state-owned banks, namely the Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China, China Construction Bank, and Bank of ChinaThese banking giants have consistently outperformed the market, with their stock prices reaching historic highs not seen beforeA closer examination of this phenomenon reveals several key factors contributing to this upward trajectory.

On December 25, the banking sector continued to demonstrate robust momentum, with the stocks of the top four banks yet again closing at unprecedented levelsICBC, for instance, experienced an intraday surge of 3.83%, pushing its share price beyond the 7 yuan mark, even momentarily surpassing the market capitalization of China Mobile

By the end of trading, ICBC had increased by 2.36%, while the other three major banks also reported gains exceeding 1%. This bullish trend illustrates not only the strength of these institutions but also the underlying shifts in market dynamics.

Interestingly, the Hong Kong stock market was closed the previous day, leading to significant gains in several Exchange Traded Funds (ETFs) that focus on banking stocks and high-dividend assets, including those that simultaneously invest in A-share and H-share bank stocksFor instance, the China Merchants CSI Bank AH Price Select ETF reached its trading limit, concluding with a remarkable 6.94% rise, setting another record highOther ETFs, such as the Caitong CSI Hong Kong Stock Connect High Dividend Investment ETF and Caitong CSI Hong Kong State-Owned Enterprises ETF, also rebounded with gains exceeding 2%.

This exceptional performance isn’t merely a flash in the pan; the banking sector has steadily outpaced the broader market throughout the year

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The banking industry index has recorded a cumulative increase of 34.62%, ranking it at the pinnacle among all sectors tracked by Shenwan Hongyuan, with a notable outperformance of approximately 18 percentage points over the CSI 300 indexSuch a trend is unprecedented in the last decade and signals a significant change in investor sentiment toward banks.

One of the driving forces behind this sustained rise in bank stocks appears to be substantial foreign investmentMajor foreign investment firms have significantly increased their holdings in Chinese bank stocks, contributing to the sector’s strong performance relative to the broader marketAccording to data from Morningstar, funds managed by Morgan Asset notably ramped up their purchases in China Merchants Bank’s A-shares by a staggering 222.71% in NovemberBy the end of that month, they held more than $9.2 million worth of shares in the bank, amounting to approximately 67.3 million yuan at the current exchange rates

Another major player, Fidelity International, has also amassed considerable stakes in several Chinese banks, with holdings in ICBC, Construction Bank, and China Merchants Bank exceeding $90 million each by the end of November.

However, despite the impressive gains, it is essential to acknowledge that many bank stocks are still trading well below their book values, a phenomenon known as being “underwater.” Historically, these banks have been characterized by low price-to-earnings ratios and high dividend yields, which appeal to conservative investors seeking stable returnsAccording to recent statistics, the average price-to-book ratio in the banking sector hovers at about 0.62, with specific banks like Minsheng Bank and Guiyang Bank showing ratios below 0.4. This current state of valuation suggests that there is still potential for unlocking further value as market sentiment improves.

In addition to the favorable market conditions, the central government's emphasis on state-owned enterprises stressing the importance of managing stock value has been a pivotal factor

The emphasis on addressing the issue of sustained undervaluation of listed banks was particularly pronounced this year, with policy shifts indicating a potential normalization in valuations after several years of depressed pricesThe notion that banking stocks might soon return to favor in the eyes of the public and institutional investors is bolstered by ongoing government directives aimed at stabilizing and enhancing these enterprises’ market performance.

A vital element highlighted in the investment community is the role of cash dividends, which remain a primary tool in restoring investor confidenceThe average dividend yield for banking stocks over the past twelve months stood at a healthy 4.9%, with 13 banks offering yields of over 5%. Several institutions, including Minsheng Bank and Shanghai Bank, have even surpassed an 8% yield, thus becoming attractive propositions for yield-seeking investors.

Furthermore, the increase in dividend payouts reflects a positive shift in the banks’ approaches towards capital distribution

This year alone, 22 banks have either announced or already begun mid-term dividend distributions, a marked change from the previous year when banks typically limited themselves to year-end distributionsThis boost in dividend activity has raised expectations surrounding the banking sector, with the six major state-owned banks, including ICBC, proposing dividends exceeding 10 billion yuanNotably, ICBC has announced its first-ever mid-term dividend, amounting to a significant 51.1 billion yuan, emblematic of a broader trend of enhancing shareholder returns.

The apparent buoyancy in the banking sector can also be attributed to improved economic indicators and a gradual stabilization in the property market—two factors that traditionally serve as key components of bank performanceAs the Chinese economy continues to recover, the banking sector stands to benefit from increased lending activity and improved asset quality