CHINA’S new yuan-denominated loans in July amounted to 356 billion yuan. The monthly increase was the lowest this year. Urban fixed asset investment grew 32.9%, lower than expected. Industrial production rose 10.8%, also lower than expected. Exports in July were down 23% year-on-year, compared with a 21.4% decline in June.The consumer price index and producer price index dipped 1.8% and 8.2% respectively. However, retail sales rose 15.2%, better than expectations. Overall, the focus of investors was on the weaker numbers than on the stronger numbers. This slew of economic data served as the perfect excuse for the Shanghai stock market to start correcting.
In about three weeks, the Shanghai Composite Index (SCI) dived 20.6%. Since the lows reached in October/November 2008, the SCI has surged 108.9% in nine months. Investors have been saying that the rise was overdone in too short a period. No one really disagrees with this and most investors were already expecting at least a correction. So, is the current fall just an overdue correction or the start of a new bear market?
Deciphering the trend of the Shanghai stock market is not easy. It is, after all, still an emerging stock market that has grown very rapidly in an emerging economy that is transforming very rapidly. Of course, one has to bear in mind that all stock markets behave in a volatile and unpredictable manner. In addition, when an economy is in the early stages of a transformation, the stock market typically behaves in a very volatile manner.
Shanghai is no exception. The Shanghai market has a short history, being around only in the last 20 years or so. During that period, it has enjoyed four major bull markets and four severe bear markets. The first bull market from 1991 to 1992 was very short but very strong. This was followed by a short but steep bear market from 1993 to 1994. From the lows of 1994, the SCI staged a seven-year bull market that saw the index rising around seven times to a new record in mid-June 2001.
This was followed by the second bear market that lasted for around four years where the Shanghai market fell around 50% even as China’s economy was expanding robustly. The third bull market, from mid-2005 until October 2007, was exceptional in that the nearly six-fold gain occurred within less than three years. Then came the 2007-2008 bear market which plunged 72.8% in just about a year.
This was followed by the current bull market which has seen the index double in a short time. It is obvious that the four-year bear market from 2001 to 2005 had no fundamental justification as the Shanghai market was ignoring China’s attractive short- and long-term fundamentals. One can say the same thing about the 2007-2008 bear market. Given China’s long-term attractions, the plunge from 2007 to 2008 was irrational, making the China-related stocks really cheap.
However, the 2005-2007 bull market was overdone as the rise, although it was to partially make up for the time lost from 2001 to 2005, became too speculative. Can one say the same thing about the 2008-2009 rally? The current rally has been strong. From a shorter-term perspective, it was getting rather giddy but from a longer-term perspective, the Shanghai stock market will certainly see new highs, levels that would even surpass the 6,124-point mark reached in October 2007.
From a shorter-term perspective, the Shanghai market was due for a correction. From a longer-term perspective, China’s economic development has many more decades to go. The Shanghai market will follow suit. Once the current correction is over, the rally in Shanghai will resume. However, one needs to note that the Shanghai market does not have to move in tandem with the economic cycle on a quarterly or annual basis.
A good example would be from 2001 to 2005. Whether the current correction will be over soon or it will be a prolonged pause is hard to say but one thing is clear: a repeat of the 2007-2008 or 2001 to 2005 bear market is highly unlikely and a repeat of the 2005-2007 bull market is also unlikely. Given the steep and irrational plunge in 2008, it is not surprising that the subsequent rally was so strong but the future trend from now onwards would be more subdued, more gradual, relative to the movements in 2007, 2008 and 2009.
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