Mainland stocks are attractive compared with the past and their regional peers, and investors should buy more "deep cyclical" sectors tied to the country's recovering economy, HSBC Global Asset Management said.
The Shanghai Composite Index yesterday fell 1.03 per cent to 1.959.77 points, the lowest close since early 2009. It is now trading at nearly 11 times last year's earnings, the lowest since at least 1997.
Cement and sportswear makers might have the best opportunities to outperform the market next year, said Mandy Chan, an investment director and the head of Chinese equities at HSBC.
Chan said it was unlikely that the market would weaken further because it was relatively inexpensive now.
Cyclical shares have been underperforming the market this year.
The three leading Hong Kong-listed mainland cement companies - China Resources Cement, Anhui Conch Cement and China National Building Material - have gained on average only 4.6 per cent so far this year. That compares with an 18 per cent growth in the Hang Seng Index.
Morgan Stanley calculated recently that investors who bet on defensive stocks such as utilities and consumer staples would have reaped 40 per cent more this year as of late last month than if they had invested in such cyclical counters. "Sales may see a sharp turnaround for some cyclical firms as they could be able to digest their current inventories within the next six to eight months," Chan said.
Cement production at some makers might fall sharply in the second half of next year, pushing prices up and supporting a potential sharp earnings growth, she said.
The HSBC fund manager also favours railway-related shares, as the nation's rail ministry continues to tap the bond market for cash to fund expansion. Government approvals of new railway projects are also expected to soar next year.
Shares of mainland property developers, however, were looking pricey after a strong rally this year, Chan said.
Developers' shares were broadly weak in Hong Kong yesterday as investors sold stock to lock in profits.
The biggest mainland developer, China Overseas Land & Investment, dropped 2.61 per cent, trimming its gains for the year so far to 72 per cent.