New year, new woes for China stocks

Here's the real indicator of slowing China growth

Chinese stocks hit their lowest level in almost five months on Monday, with some strategists warning that investors are yet to heed what the battered equity market is saying about the world's second biggest economy.

The benchmark Shanghai Composite index fell more than 2 percent to around 2,034 points following news that growth in China's services sector slowed sharply in December.

(Read more: China services sector at slowest pace in over 2 years)

On top of a 7.6 percent fall last year that made China's equity market one of the worst performers in Asia, the Shanghai market has shed a further 4 percent since 2014 began less than a week ago.

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According to James Gruber, author of investment newsletter "Asia Confidential," the stock market is pricing in an economy that is in trouble and which has been for some time.

"People haven't been paying enough attention to the stock market," he said. "They've been looking at GDP [gross domestic product] numbers, while the stock market has been telling them that something isn't right there. Does it [the stock market] go down from here? I think so."

(Read more: China 'major' uncertainty facing global economy: Soros)

The Shanghai Composite is down more than 65 percent from a peak hit in 2007. While Wall Street shares hit record highs last year and Japan's blue-chip Nikkei soared almost 57 percent, China's market ended 2013 in negative territory.

Analysts say concerns about risks to financial stability, especially from high debt at a local government level, a recent run of weaker-than-expected economic data and the recent lifting of a freeze of new listings have all hurt the Chinese stock market.

Six-month chart for Shanghai Composite

(Read more: End of China's IPO freeze really bad news for stocks?)

"At the end of the day when we look at China there tends to be extreme views and the truth probably lies somewhere in the middle," Catherine Yeung, investment director at Fidelity Worldwide Investment, told CNBC Asia's "Squawk Box."

"We are seeing economic growth slow, which is going to happen," she added, referring to the government's efforts to shift the economy away from investment-led growth to consumption. "There is also an issue in terms of a debt mess, but what is positive is that China's new leaders are addressing the problems that are there. It is a slow process."

Chinese markets could rise 15% in 2014 : Pro

(Read more: Time to get picky on China stocks: HSBC)

She expects the stock market to rally about 15 percent this year, while Jim McCafferty, managing director and co-head equity research at CIMB Securities, expects gains of 20 percent amid concerted efforts by Beijing to reform the economy.

China unveiled sweeping reforms in November such as easing the controversial one-child policy and relaxing the system of household registration. On Monday, Beijing issued new rules to strengthen regulation of the shadow-bank lending system that has fueled debt levels since 2008, Reuters reported.

"We see 20 percent upside for China markets, driven by reforms announced since the Third Plenum last year," said McCafferty. "The country has an obligation to keep economic growth going and we expect 7.5 percent GDP growth this year."

China is expected to release fourth-quarter GDP data later this month. Economists polled by Reuters forecast the economy grew 7.6 percent from a year earlier, versus a 7.8 percent rise in the third quarter.

— By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter @DharaCNBC