Volatile year of epic changes in the offing

Hong Hao, chief strategist at BOCOM International, shared with China Daily his view on the outlook for China's stock markets in 2017.

What is your view?

Contrary to bullish consensus, our model estimates the likely trading range in 2017 for the benchmark Shanghai Composite Index to be around 3300 +/- 500, suggesting perhaps a better year than 2016 (the same model estimated 2900 +/- 400 for 2016 exactly 12 months ago) but with wider return dispersion to reflect rising volatility. Further, two-thirds of the estimates are lower than the current index level of 3300. We remain guarded and urge attention on the downside risk.

What factors will influence the A-share market the most in the coming year?

While the expectation is that inflation will likely rise, growth may not eventuate, as investment will likely fall with property curbs. As such, the Chinese economy is stuck between mild cyclical reflation and outright stagflation. It will continue to traverse an L-shaped trajectory, as it has since 2012. The key to the A-share market trend would be whether or not China's economy will grow as strongly as expected.

What are the major risks that investors should be prepared for?

The historic low real interest rate feeds asset bubbles. More restrictive property curbs are likely to come, to deal with surging property prices. However, the curbs will also cut liquidity and have a negative impact on the equity market.

Unexpectedly high inflation could be another major risk that may put the yuan under heavier depreciation pressure. If capital control is instigated to slow down onshore renminbi's depreciation, then onshore/offshore exchange rates will diverge, obliging market interventions such as cutting offshore renminbi supply and raising offshore renminbi borrowing costs. But higher interest rate offshore will eventually roil the other asset prices, such as equities.

What is your trading advice for A-share investors?

The New Year is destined to be one of epic changes and volatility. We should focus on convexity trades with option-like payoff and think in probabilistic scenarios, instead of being overly engrossed by the perpetual futile debate of 'bull vesus bear'. We see a strengthening US dollar, rising inflation and long bond yield, as well as a weakening renminbi. In the first half, there should be opportunities in financials, materials, energy, industrials, tech and consumer discretionary.