The new China rules for investing

(Fortune) -- It feels nothing like 2007 these days, except in one respect: Chinese stocks are outperforming again. The MSCI China Index, which tracks stocks traded in Hong Kong, has climbed 67% since late October (the S&P 500 has risen 2% in that time).

Analysts are debating whether or not the rally - which has slowed in recent weeks - will persist. Morgan Stanley strategist Jerry Lou warned investors last week that Chinese stocks were overvalued, writing in a note, "Although we now envision a marginally less severe earnings recession in 2009...the market has rallied ahead of fundamentals." Meanwhile, Goldman Sach's Hong Kong strategist, Timothy Moe, raised his forecasts for two Chinese stock indexes on Monday.

"People are worried that these stocks have run up too far," says Hong Hao, an analyst at Brean, Murray, Carret & Co. "But we're still talking about extremely low valuation multiples." The price to earnings ratio of the MSCI China index is currently 12 - three points higher than it was last fall, but twenty points lower than it was in late 2007.

Like U.S. companies, Chinese businesses are reporting underwhelming (although less dismal) earnings. Telecom China Mobile's 5% profit growth last quarter fell below analyst estimates, and state-owned carrier Air China's earnings declined 6%. But while the U.S. market has received little support from its sagging economy, China's economic data has perked up.

"Just about every indicator in China suggests that things have been looking up for months," says Larry Kantor, the head of research at Barclays Capital. "If I had to pinpoint a bottom, I'd say it happened in November or December."

Last fall, the Chinese market was stuck in a rut - stocks sank 60% from August through October, and the country' once-unstoppable gross domestic product growth began to peter out. When American investors' emerging market funds plummeted, they learned that China's export-driven economy was far from decoupled from the U.S.

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