The recent sharp rally in Chinese electric vehicle (EV) stocks has many cheering. In a research note released Thursday, Deutsche Bank explains why this is happening and what investors need to watch out for.

Chinese EV stocks were up an average of 40 percent over the past month, well above the S&P 500's 2 percent and the MSCI China Tech Index's 7 percent gain, noted Deutsche Bank analyst Edison Yu's team.

Li Auto led the way with a gain of more than 50 percent, which may have been helped by a short squeeze, followed by Nio and Xpeng Motors both up nearly 40 percent, Yu said. By comparison, Tesla was up just 9 percent over the same period.

In addition to benefiting from a broader rise in growth stocks, Deutsche Bank sees several factors behind this:

Easing concerns about local competitive pressures as tech entrants (Baidu, Xiaomi) likely won't have any credible products on the market until 2023-24 and other new EV efforts would likely take away market share from JV related ICE sales instead of competing directly against other Chinese BEVs.

Tesla facing bad PR on social media and reports it is facing a softer order book in China.

Sequential demand/sales improvement looking increasingly robust as semis supply situation improves (e.g., Li Auto targeting 10k monthly deliveries by Sep vs. May at 4.3k).

After seeing these sharp gains, Yu's team cautions that their conversations with investors have found that current sentiment about the group has been a bit too bullish in the recent past, so it wouldn't be surprising to see some pullbacks as their volume growth upside is widely understood in the second half of the year and Tesla's local woes begin to dissipate.

They see the recent Hong Kong listing of Xpeng as a reminder to investors that all of these companies are opportunistic in raising capital to build a large war chest for the future. "We note both Nio and LI raised capital through a convert offering earlier this year," the report said.

In addition, Xpeng and Nio both released June delivery figures on Thursday, with the former delivering 6,565 units and the latter 8,083 units.

In the second quarter, Xpeng delivered 17,398 units, beating Deutsche Bank's estimate of 16,000 units and the company's guidance of 15,500-16,000.

Nio delivered 21,896 units in the second quarter, roughly in line with Deutsche Bank's estimate of 22,000 units and at the upper end of the firm's 21,000-22,000 guidance.

Yu's team expects Nio's sales to grow further in the upcoming quarters as supply chain conditions improve and strong order intake is met.

The team also expects BEV sales in China to reach 180,000 units in June, a new high for the year, up 150 percent year-on-year and up 7 percent from the previous month. For NEV sales, which include PHEVs, the team expects June figures to be 214,000.

Nio, Xpeng, Li Auto and Tesla all fell Thursday amid a sell-off in broader growth stocks, with Nio down more than 4 percent, reversing gains in pre-market trading following the release of delivery data.