In this paper, we use a Markov regime-switching model to analyze hedge fund performance in China, distinguishing between economic expansion and recession phases, and we employ a stepwise regression method to identify the key factors influencing hedge fund strategies within each economic regime. This model adeptly captures the nonlinear characteristics of hedge fund returns, allowing for a precise assessment of performance fluctuations tied to different economic states. Our findings reveal that during economic expansions most hedge funds struggle to generate significant positive alpha and rely primarily on momentum strategies. However, during recessions, hedge funds strategically reduce their risk exposure, with neutral, event-driven, arbitrage and bond strategies, for example, showing the ability to generate positive alpha returns. This shift in risk exposure and asset allocation underscores the adaptive strategies used by hedge funds to mitigate risks and capitalize on opportunities during downturns. This study provides a comprehensive analysis of hedge fund performance in China, a rapidly evolving financial market that presents unique challenges and opportunities distinct from more developed Western markets.