The Chinese capital market has experienced dramatic development over the past twenty years. We can read the stories in the candlestick charts of every rise and fall. By recalling past market performance, we are able to understand the theme that ran through the history of the A-shares.
A turn of peaks and dips
According to the large cycles that comprise both the bull and bear markets that the A-share market has experienced over the past twenty years, we can divide the history of Chinese A-share market into three stages.
The first stage was from 1990 to 1999, during which time the A-shares experienced the swapping of bull and bear markets four times. The Shanghai Composite Index started at 100 points, making 1,000 points its average value and 1,500 points its peak over those ten years. The Chinese A-share market had just gotten started during this period, and the swapping of bull and bear markets usually happened very quickly, resulting in rapid surges and sudden slumps.
The second stage was from 1999 to 2005. During these six years, the Chinese stock market, for the first and only time, underwent the smooth swap of a bull and bear market. The market climbed up to 2,245 points in two years and was then followed by a bear market that lasted four years. During this period, A-shares dipped to 1,000 points, peaked at 2,000 points, and had an average value of 1,500 points.
The third stage took place during the period from 2005 to 2009. The A-share market entered a super bull market since the second half of 2005 and the Shanghai Stock Index was up more than five times in only one year. The record of 6,124 points set on October 16th, 2007 has become a peak that the A-shares may find hard to surpass for a long time to come. Following the super bull market there inevitably came a super bear market, prompted in part by the global financial tsunami, and the index fell to its lowest point, 1,664, on October 28, 2008. So, the peak of the first stage and the average value of the second stage became the low point of the third stage.
Policy leads market development
China has been exploring ways to regulate the securities market in an effective way for the past twenty years. We can easily find the impact of policy directivs in each swap of the bull and bear markets.
Again, the history of the Chinese stock market can be divided into three stages. The first stages began in 1990 and ended in 1999. The stock market had just been introduced in China, and during that period China was undergoing an overhaul of its economic system. It had just said farewell to the planned economy and shifted to a market oriented economic model. So, it was very hard for the market to exercise self adjustment, and hence had to resort to policy support. During this period, every time the government came up with measures to adjust the market, it brought turbulent fluctuation.
During the second stage from 1999 to 2005, the existing trading systems and corporate governance mode were no longer able to handle the rapidly expanding securities market. Such inadequacy urged the relevant authorities to improve macro controls. During this period, shifts in major policies had a huge impact on the long-term market trend.
During the third stage from 2005 to 2010, a series of major improvements has been made in the securities market, such as the implementation of non-tradable shares reform, the release of the Securities Law and Corporate Law, the re-launch of IPOs, the unlocking of restricted shares, and the debut of index futures and the scheme of short selling and margin trading. Due to these reforms, A-share stock indices started to move more in line with economic fundamentals.
Liquidity becomes the dominating factor
With improvements in the basic systems of the Chinese A-share market, liquidity gradually becomes the key factor effecting market performance. A closer look into the correlation between the movement of the monetary liquidity denominated in the M1 growth rate and that of the Shanghai Composite Index shows that monetary liquidity served as a leading indicator for market movement. Especially during the years after 2005, we can find the impact of a change in the pace of M1 growth rate almost each time the market shifted from bull to bear or vice versa.
China Merchants Securities introduced the concept “monetary loophole” in a strategic report in August 2008. Monetary loophole, the difference between the growth rate of M2 and that of nominal GDP (real GDP plus inflation), has proven to be the most vital and direct variable to explain and observe the cyclical fluctuations of the Chinese capital market. When M2 grows at a pace faster than that of nominal GDP, a bear market is soon to come. On the contrary, when nominal GDP grows at a pace faster than that of M2, a bull market is just around the corner.
Future prospects to be outlined
History tells us that technical movement, policies, and liquidity are the three factors that inherently affect the Chinese A-share market. As we look forward to the future, trending upward and growth oriented will be the key words for the A-share market.
Technically, the average value of the A-share market has continued moving upward in every cycle of the bull and bear markets. This trend is sure to continue. Yet, it will take time for us to test our assumptions on the new stage since 2008.
At the same time, the ways of regulating securities market have shifted from administrative intervention to market–oriented control over the past 20 years. Two future development paths are foreseeable. On one hand, with the enhancement of non-tradable shares reform, more and more shares have realized full listing. Movements of stock prices and stock indices have become increasingly more closely tied to company fundamentals and macro economics. Relevant authorities therefore have to tackle economic fundamentals rather than the securities market in order to ease market volatility. On the other hand, as China gradually opens capital projects to the world and the internationalization of renminbi becomes a reality, regulation of the securities market will also be required in order for it to be integrated into international markets.
In addition, the condition of liquidity, after all, is a function of the macro economy. In this sense, as long as the Chinese economy maintains growth and the renminbi continues to appreciate, abundant liquidity will continue to push the Chinese market upward in the long run.
Janet Shen can be contacted at FNCHN