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,[Company Registration in USA] 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.

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 [Company Formation | Offshore Company | Company Incorporation]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.