Caution prevails in outlook for stock market

Q: How will China's reform process affect the stock market?

A: China's reform plan, if fully implemented, will help to eliminate long-term risks inherent in economic growth. That is positive for the stock market. However, in the early stages of reform, the situation may be complex, with multiple polices rolled out and various factors intertwined. That will increase difficulties in investment.

For example, the government's stated goal "to allow the market to play a decisive role in allocation of resources" means institutional optimization will inevitably play a major role in economic transformation and long-term stable growth, but the interests of monopolistic state-owned enterprises may get hurt in the near term. Therefore, we expect significantly stronger A-share market fluctuations in 2014.

Q: How do you see the performance of the A-share market in 2014?

A: We expect a 12 percent increase in the CSI 300 Index. Corporate profits may rise 11.5 percent year on year in 2014, due to a moderate economic recovery, while the overall A -share PE multiple may remain at around 8.

Specifically, we expect the market to go down first before moving up. We're cautious about the market in the first half of the year due to the risk of money-rate fluctuations.

In 2013, China's capital market has experienced two severe liquidity crunches — the money market in June and the debt market in November. Frequent money-rate fluctuation is normal during the interest rate liberalization process, referring to experiences in other countries. We think dramatic fluctuations in money rates will recur in 2014. It's more likely to arise in late spring or early summer and thus depress the market.

Q: What sectors do you think are promising in 2014?

A: We believe thematic investment will still play a major role in 2014. Among the investment themes, we favor state-owned enterprise reform, land transfer and financial innovation.

I think the biggest opportunity provided by the SOE reform is the re-allocation of state-owned assets, during which state-owned capital will exit from some competitive industries while enhancing its presence in other sectors, such as resources and social security.

For example, Shanghai said it plans to reduce the number of sectors controlled by state-owned assets from 47 to 25 in two to three years; Tianjin will also reduce the number from more than 70 to 44.

For investors, opportunities lie in two aspects. Sectors where state-owned assets will exit — such as consumer staples, tourism, real estate, home appliances and retail — may regain vitality and have chances to be rerated. There are also opportunities in strategic emerging industries and non-free market industries, such as national defense, where the government may concentrate its resources.

For land transfer reform, the most important implication is that it may increase incomes of farmers and residents in small towns. That will promote consumption and strengthen demand for clothing, food and beverages, home appliances, telecoms and automobiles in third- and fourth-tier cities.

Meanwhile, we're positive on securities and insurance sectors because ongoing and forthcoming financial reforms will bring them new earnings drivers. We have seen multiple reform measures in financial areas since the Third Plenum of 18th the Communist Party of China Central Committee, which meet and even exceed market expectations.

But I think 2014 is the starting of a new era for financial innovation in China because the government needs new financial products to absorb the massive local government debt, which has amounted to 17.9 trillion yuan according to the latest audit data. In 2014, we may see new financial products, such as individual stock options, and a slew of financial reforms including the expansion of asset securitization and establishment of a deposit insurance system.

Q: What's your opinion about the property sector?

A: I think real estate as an investment asset is becoming unappealing. First, residents' purchasing power is unlikely to increase significantly amid the economic slowdown. Secondly, the central government's plan to increase housing supply will be efficient to bring down home prices. And thirdly, funding costs will rise during interest liberalization and thus further depress purchasing power and home sales.

However, I think shares of property companies will still be profitable in the long term because home sales have been robust in the past three years, enabling property companies to enjoy good cash flows.

Q: What industries should investors avoid?

A: As I have mentioned, investors should avoid small-cap shares on the mainland market after March due to a flood of IPOs. Meanwhile, I'm still quite pessimistic about commodities. The debt ratio is quite high in that sector, and there is not much room for their shares to rebound.