The rally in Chinese stocks entered its second week Wednesday morning, with shares of Temu owner PDD Holdings (PDD 5.96%) rising 6% through 10:10 a.m. ET. This was followed by internet search giant Baidu (BIDU 2.58%), which gained 3.9%, and Pizza Hut and KFC operator Yum China Holdings (YUMC 4.43%) bringing up the rear with a gain of 3.6%.

The reason today, as it's been for the past week and more, is a series of subsidies and other stimulus measures announced by the Chinese government last week.

The details of China's stimulus

With China's economy in contraction and looking likely to miss its target growth rate of 5% in 2024, China's central bank, the People's Bank of China (PBOC), announced multiple flavors of interest rate cuts to lower the cost of borrowing and, thereby, encourage spending. Interest rates are expected to fall by anywhere from 20 to 30 basis points, and home mortgage down payments will be capped at 15%.

In a novel twist, the PBOC also announced that more than $110 billion in funds will be made available to subsidize institutional investors buying Chinese stocks and for Chinese companies to use to buy back their own stocks.

The rate cuts seem designed primarily to boost consumer spending, which should incrementally help the businesses of PDD (an internet retailer), Baidu (which sells ads to encourage buying), and Yum China, a restaurateur. At the same time, the mega-billion-dollar stimulus to stock shopping could actually be the bigger factor lifting stock prices this week.

What happens next?

Granted, all these factors were at play last week as well as this week. But why are these stocks still going up in this second week of a rally that's now seen China's stock market value grow by nearly 25%?

Well, not to put too fine a point on it, but the reason Chinese stocks are still going up today is because Wall Street is telling investors they will keep climbing. As China's South China Morning Post (SCMP) explained this morning, Wall Street was caught flat-footed and "short" China before the PBOC announced its stimulus. A lot of last week's rally, therefore, constituted a short squeeze in which China bears were forced to cover their short bets by buying back stock. Now, though, the pendulum is swinging the other way.

Surveying investment banks, SCMP notes that UBS is forecasting a further 7% rise in China's stock market through just the end of 2024. Morgan Stanley sees the rally going up another 10%. And Japan's Nomura, likewise, forecasts a gain of a little more than 10%.

Are they right about that, though?

Probably not, if their forecast for a continued stock price run depends on continued short squeezing. According to Yahoo! Finance data, only 2.4% of PDD Holdings stock is currently sold short (not a big number). Baidu's short interest is similarly small -- just 2.5% -- while Yum China's isn't much bigger at 2.6%.

Viewed from a valuation perspective, though, the bankers may have a case. While Yum China's rally is looking a bit long in the tooth, with the stock now costing nearly 23 times trailing earnings, both Baidu and PDD stocks still look relatively cheap at price-to-earnings (P/E) ratios of just 14 and 15, respectively.

Granted, even a cheap P/E isn't necessarily a bargain if a stock isn't growing earnings much. Ultimately, investors should decide whether or not they think China's stimulus measures, as described above, are big and bold enough to jolt the Chinese economy (not just the Chinese stock market) out of its funk. If you do believe that, then Baidu and PDD stocks could be buys.

But if you don't, they aren't.