Financial markets often act in counterintuitive ways that leave the majority of investors on the sidelines or on the wrong side of the trade. We are seeing something similar happen as the iShares China Large-Cap ETF (FXI  ) is up nearly 50% since the October lows. And, this outperformance has only accelerated in 2023.

The biggest impetus for this outperformance is the country embarking on relaxing its Covid-zero policies regardless of the collateral damage. Previously, the country had relaxed its stance only to reinstate lockdowns at the first sign of rising cases. However, it's clear that there is a real pivot in its policy as the country seems to be prioritizing economic growth over limiting case counts, in addition to massive public opposition to continuing these policies.

Already, there are strong rebounds in all sorts of indicators like the number of cars on the road, ridership on metro stations, and domestic air travel. Another policy change is that its crackdown on large businesses seems to be over which is another sign that business is returning to normal.

The combination of uncertainty around the country's lockdowns, COVID policies, and weak global growth over the past couple of years resulted in Chinese stocks being major underperformers relative to the rest of the world.

Of course, another factor has been rising tensions between the U.S. and China with many believing that Chinese stocks listed in the U.S. could be collateral damage. Even here, there are signs of improvement as President Xi seems to back away from Russia, while he has sidelined some of the most prominent anti-U.S. voices in the government. It's a change from the harsh tone that has defined interactions between the two countries.

In fact, the Shanghai Stock Exchange is down 40% from its 2015 peak, while the S&P 500 (SPY  ) is nearly 100% higher even after the recent bear market. Zooming back even more, we can see that the Shanghai stock exchange has been range-bound since 2005. And, this range has been narrowing over time.

Typically, these ranges tend to break dramatically in one direction or another. For a couple of years, it's been fashionable to bet that the range would break to the downside given the numerous headwinds. Yet, many of these headwinds were self-imposed and now moving in a much more supportive direction. On top of this, Chinese stocks are quite cheap with many of the largest companies trading at single-digit multiples.