By Xie Yu

Chinese tourism stocks are flying high, thanks to a bet by investors that travelers will stick to domestic excursions due to the pandemic and also take advantage of relaxed duty-free rules.

While Covid-19 means the global travel industry is in dire straits, holiday-making inside China is recovering because the country moved fast to suppress the novel coronavirus. That has allowed China's economy to return to growth in the second quarter--and made Chinese sales a bright spot for many U.S. companies.

State-backed China Tourism Group Duty Free Corp. has surged 143% in Shanghai this year, helping fuel a 19% rise in the CSI Tourism Thematic Index, whose constituents include operators of scenic spots, travel agencies and hotels. The smaller Caissa Tosun Development Co. has gained 84%, aided by its own plans to tap opportunities in the duty-free business.

In contrast, the Stoxx Global 1800 Travel & Leisure index, a broader global gauge that includes owners of airlines, casinos, cruise lines and restaurants, has lost more than 22.9% this year.

One powerful driver of the rally is that Chinese travelers can now spend bigger sums tax-free on goods including cosmetics and mobile phones without traveling abroad.

In June, authorities more than tripled the annual limit on duty-free purchases in Hainan, the southern island province, to 100,000 yuan ($14,360) a person, and widened the program to include more products such as electronics.

Billy Ng, analyst with BofA Securities, said the changes in Hainan suggested China wanted to win market share from places such as South Korea, where annual duty-free revenues are roughly $18 billion. China is a major source of global duty-free revenues.

A clampdown on "daigou," or middlemen who buy goods abroad and resell them in China, is also likely to fuel more domestic duty-free sales.

Outside of duty-free retail, the gains have been less even. For example, Shanghai Jinjiang International Hotels Development Co., which focuses on budget hotels in the Chinese mainland, is up more than 55% this year. Meanwhile, upmarket rival BTG Hotels (Group) Co. is down 7%. Nate Deng, lodging and tourism analyst at China Renaissance Securities, said BTG was hurt partly by its heavy exposure to Beijing. The capital has adopted stricter travel restrictions than elsewhere in the country to contain the virus.

Sherwood Zhang, a portfolio manager at Matthews Asia, said investors had piled into tourism and duty-free companies, expecting domestic travel in China would recover faster than elsewhere.

"The pandemic has caused pent-up demand for traveling," Mr. Zhang said. "A lot of people were betting that with international traveling remaining dismal, traveling and shopping within China would boom."

In an illustration of the gap, the hotelier Huazhu Group Ltd. has said 97% of its domestic hotels reopened in the three months to June, while as of June 30, only 79% of hotels under its European-focused Deutsche Hospitality subsidiary were open. Huazhu's U.S.-listed shares are down 11% in the year to date.

Even inside China, travel remains below pre-pandemic levels. While the airline industry has recovered somewhat since February, the aviation authority said the number of travelers taking domestic flights in June was still down more than 35% from the same time a year earlier.

Preliminary July data from STR, a hospitality data specialist, shows hotel occupancy rates at 56% and revenue per available room, a standard hotel-industry measure, down 24% year over year at about 242 yuan per night.

A July survey of mainland Chinese residents by BofA Securities found 28% of respondents considered even domestic trips risky. Outbound trips, to destinations outside mainland China, Hong Kong or Macau, were seen as risky by 79% of respondents.

Some investors see room for further gains in Chinese travel stocks.

Tom Masi, co-portfolio manager of the Emerging Wealth Equity Strategy fund at GW&K Investment Management in New York, said travel-related stocks offered some of the most attractive potential investment returns over the next one to three years. Mr. Masi said his fund had increased its positions in Huazhu, Chinese online travel agent trip.com, and Macau casino operator Sands China Ltd.

He said since global stock markets cratered in March, Huazhu had outperformed U.S. rival Marriott International Inc. "We believe that Huazhu has performed better because China is ahead of the U.S. in terms of controlling the virus," Mr. Masi said, highlighting a similar gap between Sands China and its parent company, Las Vegas Sands Corp. "We also believe China is more likely to return to normal earlier," he said.

Write to Xie Yu at Yu.Xie@wsj.com