Shanghai is my contrarian call for 2014

The stock market is not good at nuance. The reality is somewhere between the super-bullish and the super-bearish story but in valuing the Chinese stock market investors have turned their backs on the growth story to focus on the problems.

Chinese stocks trade at nine times this year’s expected earnings, compared with 12 times earnings for the Asia region as a whole. In Hong Kong, that ratio is 15 times, about the same as in Japan and America. The UK trades on 13 times this year’s earnings.

One reason why shares are rated so lowly in China is the expectation that the radical reforms unveiled last November in Beijing will curb growth. This is probably true and China sceptics will no doubt use this moderation in growth to argue that it is “game over” for the Chinese miracle.

I see the slowdown as a positive. For me, it is a sign of President Xi Jinping’s seriousness about bursting the investment bubble and steering China towards a better balanced economy. The leftward drift of politics at the same time as the economy swings to the right lays the groundwork for a consumption-driven boom in China that could last for years to come.

The steps the government took in 2008 delayed this essential rebalancing, but were unavoidable. They also created inflationary pressures and reduced social stability. In some ways, China has paid a high price for America’s financial crisis.

This combination of general gloom about the outlook in China, radical change in the economy, slower but more sustainable growth and far-reaching reforms that favour consumers is an exceptionally attractive one for stock-pickers. It means companies have a great opportunity to grow in a wide range of industries and investors have a great opportunity to pick up this growth on the cheap.

The obvious approach is to concentrate on consumer-facing sectors such as retail, the internet and healthcare, and these will no doubt do well. But the reforms outlined last year will also throw up opportunities that are less well understood. The push to reduce pollution in China, for example, is good for alternative energy stocks.

A little over a year ago, the consensus view of Japan was gloomy and its shares traded at historically low valuations. The performance of the Nikkei in the first six months of 2013 showed what happens when a change of sentiment is applied to an oversold market.

The most important driver of future investment returns is the price you pay at the outset. Things are rarely as bad as investors believe when they turn against a market, as they have against China in the past couple of years. And for that reason, the Shanghai market is my contrarian call for 2014.

Tom Stevenson is investment director at Fidelity Personal Investing. The views expressed are his own. He tweets at @tomstevenson63

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