EDITOR'S Note: China has been beefing up efforts to create a transparent and efficient capital industry in the past few years. With the introduction of a myriad of infrastructure reforms and financial innovation, the mainland equity markets have growingly become hectic and sophisticated. Shanghai Daily today launches a column to let experienced investment professionals offer their insights of market drivers and select hot chips. We welcome your opinions and comments on the series. Please send them to business editor Leo Zhang at leozhang@shanghaidaily.com.
Shanghai's benchmark stock market dropped 2.3 percent last week to a nine-month low, amid concerns about tighter monetary policy after the central bank raised for the sixth time this year the amount of reserves banks are required to keep on hand.

The tighter credit imposed by the People's Bank of China came after May data showing inflation at a 34 month high.

So what does this all mean for the stock market going forward?

Shanghai Daily put that question and others to Yan Xu, Deputy Chief Investment Officer with BNY Mellon Western Fund Management Co Ltd. (Due to industry policies, Yan is prohibited from discussing individual shares.)

Q: The Shanghai Composite Index is now where it was last September 29. Do you think the market is at the bottom?

A: It's difficult to determine where the market bottom is and when the market will rise. Stock prices reflect China's overall economic situation and the valuation of shares.

As for recent declines, I think that's quite normal because China's economic fundamentals are a bit hard to read right now. Indexes such as PMI are all starting to fall, which means growth is on a slower track. That, of course, is something the government wants to see after all this tightening.

However, this is just a start. It will take some time for the economy to really slow down, then stabilize and finally rebound again. This process could be painful for investors because all the uncertainties make them worry how far the tightening will go. In that event, they would prefer to leave the market or to reduce their exposure to stocks. That's what has made the market so weak recently.

But if people are patient enough, they can find some ideal investments in a weak market. Shares, especially those in the CSI300, are much cheaper than before. If a company forecasts annual profit growth of 30 to 40 percent and its shares have a price-earnings ratio of about 20, then it could be a good investment to consider.

Q: I agree with you that shares are a lot cheaper than before. But is there anything else beside a low PE level that you should consider before deciding to buy a share?

A: PE level is just one of the measures that can help us determine whether it is safe to buy this stock. But there is another factor that I think is important to follow: insider corporate buying and selling.

The market used to have only institutional investors as major players, but now corporate executives and big stakeholders can also influence share prices.

For example, if major shareholders or executives of a company decide to increase their holdings, it might be a signal for small investors to buy in, too. Big players will invest more money in a company if they know there's profit to be made.

Q: So you are saying people should monitor the trading of big players?

A: Yes, that can be a factor in deciding whether the company's shares are cheap enough to buy. However, everything has exceptions. Sometimes, executives of small firms sell parts of their company holdings simply because they might need of cash at that time, not because they are confident about the company's future. Sometimes, for investors like pre-IPO private equity funds, they will take profits as soon as their locked shares become tradable.

So basically, whether the stock is worth buying or not still depends heavily on a company's ability to make profits. If earning forecasts and financial balances sheets are all fine, then the company may be a candidate to consider.

(In Chinese mainland markets, executives of companies are required to report transactions to the public of their sales or purchases of their companies' shares within 30 days when the blocks of shares are no less than 1 percent of the company's total equity volume.)

Q: You mentioned earlier that stocks in the CSI300 basket, mostly big caps, are showing low valuations. Which sectors do you find most attractive?

A: I think the market now is working in a different way from before. In the past five or six years, a lot of companies rode along with China's booming economy and their stock prices rose simply because their industry was developing fast. For investors, as long as they picked the right sector, it didn't really matter whether a particular company was doing well or not.

But in a relatively more stable economy such as now, things are different. There can be significant differences within sectors.

Small firms may find it harder to survive when demand turns weak and liquidity becomes tight. I think now is the time to focus more on industry leaders whose market dominance was cemented during China's economic boom and restructuring.

As I said before, it doesn't really matter whether the company is in the cyclical sector or the consumption sector. It's the company's ability to make money that counts.

Q: Companies will soon release second-quarter earnings, and many analysts are predicting the results won't be pretty. So how do you think the earnings season will affect the market?

A: Some sectors, such as machinery makers, are likely to report slower earnings growth for the second quarter because China's PMI is already shrinking, while costs, including raw materials and labor, are increasing.

A slower economy and higher costs are what companies are facing now. So if a company is still able to report high profit growth, even in such economic conditions, then it means it's a good company.

Q: The National Statistic Bureau said 50 of 70 major Chinese cities saw home prices still climbing in May. Do you think this will invite more tightening measures and affect the share prices of property developers?

A: The tightening measures are aimed at making home prices more stable. In other words, to stop the growth in house prices or even slow the growth. It will require time to see what impact these measures will have.

Some real estate firms could be ideal investments because they are now at reasonable valuations, which means they could be safe. Plus, their profits this year and next year are pretty assured because home prices haven't budged much yet.

I think the reason housing prices are still climbing is because speculators in the sector don't have anywhere else to put their money.

The government's intention is clear: Bring down prices and raise supply. On the one hand, they don't want to hurt the industry. On the other, prices should fall so that people can afford to buy homes. This is why the central government is trying to make its affordable housing projects work.

Q: There was a momentum among companies like developers, cement makers and steel companies after the government rolled out its affordable housing plan earlier this year. But so far less than 30 percent of the projects have started construction. How do think that will affect these sectors?

A: First, I think these projects need time to complete all the paperwork and find the money before construction can actually start. It's certain that more projects will get started this year.

Secondly, the previous momentum was not only because of these projects. Shares of cement and steel companies are rising because market demand has outstripped production capacities.

China has been trying to shut down small and outdated coal and steel plants over safety and environmental concerns. What's more, these cyclical industries are not likely to see the large expansion of the past as the nation's economy slows. But for the moment, demand is still growing fast, especially for things like cement, steel, glass and coal. As long as output lags demand, their share prices will rise.

Q: I guess it's the same thing for electricity producers? China is facing serious power shortages right now. How will that play out for companies' profit prospects?

A: Yes, it's basically the same. But things are a little more complicated in the electricity industry, and there are more complex reasons behind the shortages. I don't think they will have a large negative effect on the Chinese economy though. It won't be that serious.

Q: China has been suffering drought in some regions and is now battling floods in several regions. Do you see any buying opportunities created by these natural disasters?

A: China is very likely to see more natural disasters as it pays the price for excessive development in the past few years. That could open opportunities in the agricultural sector.

For instance, after the floods, farmers will need seed, fertilizer and pesticides to try to make up their losses. This would be short-term demand. Over a longer period, the government is pledging significant financial support for the agricultural sector because it is so important to a big country like China. Support funds will help seeds firms expand. Irrigation-related shares are also likely to be among the beneficiaries.

The same theory can also be applied to companies in the food-safety industry because food safety dominates public concern now in China. However, investors still need to focus more on companies' earning abilities. After all, firms may show different performances even if they are in the same business.