Caution prevails in outlook for stock market

After a disastrous 2013, the Shanghai stock market faces the uncertainty of a rash of IPOs following a yearlong hiatus in new shares. UBS, which is cautious in its optimism about the performance of the market this year, expects fluctuations in money rates to recur. So is now a good time to buy stocks?

China's stock market disappointed investors again in 2013, with the Shanghai Composite Index wrapping up the year with a 6.8 percent decline.

In sharp contrast, Japan's Nikkei 225 index surged a stunning 57 percent over the year, and the Standard & Poor's 500 in the US soared 29 percent.

The sluggish performance of Shanghai's A-share market came despite a mild recovery in the world's second-largest economy and a year-long hiatus in initial public offerings.

So what does the new year hold? China's boldest reform package in a decade has reignited some interest in the stock market, but the resumption of IPOs is counter-balancing optimism.

Chen Li, chief China equity strategist at UBS Securities, talked with Shanghai Daily about his outlook for the A-share market in 2014.

Q: China's A-share market has been one of the worst performers among global markets for years. How would do you explain that?

A: First, it's widely acknowledged that China's economy has been slowing down and corporate profitability is deteriorating.

Another reason, which is not quite so obvious, is the process of interest rate liberalization.

China's stock market went on a downward track in 2010 when the price-to-earning ratio of A shares dropped to eight from around 12, in spite of rising corporate profits. At the same time, the scale of wealth-management products surged from billions of yuan to trillions of yuan in 2010 and has amounted to around 10 trillion yuan (US$1.6 trillion) by now.

I take the massive issuance of wealth-management products as a significant event of interest rate liberalization. It means banks are willing to offer high-return products, rather than just deposits with only 0.35 percent to 0.7 percent interest rates. The return of wealth-management products has increased to 6.3 percent to 6.7 percent recently, compared with around 3 percent in 2010.

When people can get higher, risk-free returns from wealth-management products, it makes the stock market less attractive. That's why the stock market valuation drops.

From a global point of view, China's monetary stance has been tightening in the past few years. At the same time, the US launched three rounds of quantitative easing, Japan introduced aggressive monetary easing as part of the "Abeconomics" stimulus, and the central banks in the UK and eurozone also adopted monetary-loosening measures.

Thus, comparatively, China's money rate is much higher during the interest rate liberalization process.

That's the main reason why China's stock market has been underperforming among global peers.

Q: How will the rebooting of IPOs affect the stock market?

A: The first round of IPOs will revitalize small-cap shares and give a boost to the ChiNext board in January and February. New IPOs are expected to be priced at 30 times to 40 times their earnings per share, which are still high but quite reasonable compared with the 60 to 80 level in 2010.

The new shares are likely to rise 30 percent to 40 percent after their debuts as new listings are expected to be high quality after going through strict reviews. Some investors are passionate about new listings after a more than one-year suspension. The rise will bring their PE ratios to around 40 to 50, higher than the 30 to 40 level of the existing shares on ChiNext. That explains why the first batch of IPOs is expected to push the ChiNext higher.

However, the ChiNext board will start to fall in March, and I don't see any opportunity for it to rebound again. The market will start to see a surge in new offerings from March because the securities regulator is expected to increase the supply of new shares in order to bring down the offering prices.

Also, in order to shift to a registration-based IPO system in the near future, the regulator will accelerate the pace of new offerings to clear the current backlog of IPOs as soon as possible. Thus, we estimate the market will usher in 200 to 250 new listings from March to June. That will begin to weigh on the market.