Antibubble and prediction of China's stock market and real-estate

Abstract

We show that the Chinese stock markets are quite different and decoupled from Western markets (which include Tokyo). We document a well-developed log-periodic power-law antibubble in China's stock market, which started in August 2001. We argue that the current stock market antibubble is sustained by a contemporary active unsustainable real-estate bubble in China. The characteristic parameters of the antibubble have exhibited remarkable stability over one year (October 2002–October 2003). Many tests, including predictability over different horizons and time periods, confirm the high significance of the antibubble detection. Based on an analysis including data up to 2003/10/28, we have predicted that the Chinese stock market will stop its negative trend around the end of 2003 and start going up, appreciating by at least 25% in the following 6 months. We present a partial assessment of this prediction at the time of revision of this manuscript (early January 2004). Notwithstanding the immature nature of the Chinese equity market and the strong influence of government policy, we have found maybe even stronger imprints of herding than in other mature markets. This is maybe due indeed to the immaturity of the Chinese market which seems to attract short-term investors more interested in fast gains than in long-term investments, thus promoting speculative herding.

Introduction

After the Third Plenary Session of the 11th Central Committee of the Communist Party of China in December 1978, China adopted new reform policies and committed to open to the outside. These reforms have favored China an unprecedented growth in Gross Domestic Product (GDP). If we normalize the GDP index (deflated by the Consumer Price Index (CPI) for inflation) to 100 in 1978, then the GDP index grew to 781.2 in 2001 [1]: China's economy has grown about 9% per year on average. In the past two decades, China has experienced a transition from a centrally planned economy to a market economy. During this period, one of the most important developments has been the setup of the Chinese stock market, which has played an increasingly important role in the transition of the economy.

Before the foundation of People's Republic of China in 1949, the Shanghai stock exchange was the third largest worldwide, after New York and London and its evolution over the period from 1919 to 1949 had enormous influence on other world-class financial markets [2]. After 1949, China implemented policies of a socialist planned economy and the government controlled entirely all investment channels. This proved to be efficient in the early stage of the economy reconstruction, especially for the heavy industry. However, planned economic policies have unavoidably led to inefficient allocation of resources. In 1981, the central government began to issue treasury bonds to raise capital to cover its financial deficit, which reopened the China's securities markets. After that, local governments and enterprises were permitted to issue bonds. In 1984, 11 state-owned enterprises became share-holding corporations and started to provide public offering of stocks. The establishment of secondary markets for securities occurred in 1986 when over-the-counter markets were set up to trade corporation bonds and shares. The first market for government-approved securities was founded in Shanghai on November 26, 1990 and started operating on December 19 of the same year under the name of the Shanghai Stock Exchange (SHSE). Shortly after, the Shenzhen Stock Exchange (SZSE) was established on December 1, 1990 and started its operations on July 3, 1991.

Thanks to the establishment of the SHSE and SZSE, the Chinese stock market¹ has grown rapidly. In 1991, the total market capitalization was 284.4 billion yuan (13.2% of GDP) with the float market capitalization being 85.1 billion yuan (3.94% of GDP). In 2002, the total market capitalization was 4033.7 billion yuan (39.4% of GDP) with 1167.4 billion of float market capitalization (11.4% of GDP).² The historical high happened in 2000 when the total market capitalization reached 4968 billion yuan (55.5% of GDP) with 1535.4 billion yuan of float market capitalization (17.2% of GDP). The size of the Chinese stock market has increased remarkably.

There are different types of China-related stock shares, including several tradable shares (state owned shares, legal person shares and employee shares) and untradable shares (A-shares, B-shares, H-shares, red chips and other foreign shares including N-shares and S-shares). A mainland Chinese company qualifying for equity issuance has to keep about 67% of its capital in the form of state-owned shares and legal person shares and can only issue up to 33% of its capital in the form of A- and/or B- and/or H-shares and/or employee shares during initial public offering (IPO) [2]. Only A-shares and B-shares are traded in the SHSE and SZSE. Despite of the separation of A- and B-shares, their daily (log) returns are correlated as a result of the information transmission mechanism at work [3]. There are many problems in the emerging Chinese stock market which include (i) small scale, (ii) instability, (iii) untradability of more than $\text{2}\text{3}$ of the shares, (iv) absence of shorting, (v) significant impact of government policies, (vi) over-speculation, (vii) over-valuation of the markets, (viii) widely taken short-term positions, (ix) insider trading, and (x) distempered regulation system [4]. These specific features make the market exhibit strong idiosyncracies and puzzles in addition to the more common behavior of mature stock markets [5]. The foreign shares have been found to behave differently from domestic shares in several respects [6]. The commonly reported day of the week effects [7], [8] are found to be absent in both Shanghai and Shenzhen A and B markets [9]. The acceptance or rejection of the random-walk hypothesis in the Chinese stock markets is controversial, and the conclusion depends on the approach used to perform the tests [2], [10], [11], [12]. The markets also have extremely high volatility [2] and very high P/E (price-over-earning) ratios [12], [13]. The high P/E ratios can be partially explained by the relative scarcity of shares resulting from the holding of more than $\text{2}\text{3}$ of their total number by the government.

While, as we briefly summarized, there are many problems that can distort the analysis of the Chinese stock markets, it is an interesting question to consider the possibility for behaviors similar to those which have been documented for other developed markets [14], [15], in particular in view of the documented speculative nature of Chinese investors [4]. We refer in particular to the US and worldwide “antibubble” regime found to have developed after the collapse of the so-called information and internet bubble in 2000 [16], [17]. We find several puzzles in the behavior of the Chinese stock markets in the last few years. The Chinese stock markets turned into a bearish antibubble regime (significantly decreasing prices)³ in asynchrony with most of the major world markets [17] and significantly later at a time when China's economy was still doing well. The SHSE Composite Index culminated at the all-time high of 2242.4 on 2001/06/13 and since plummeted 32.2% to 1520.7 on 2001/10/22. It reached its minimum at 1319.9 on 2003/01/03, with many strong preceding local ups and downs. Notwithstanding the asynchrony with the rest of the world, we will show below that the evolution of the Chinese stock markets since mid-2001 can be quite well described by the same concept of an antibubble.

The paper is organized as follows. In Section 2, we describe the data sets. In Section 3, we identify separately two signatures of an antibubble characterizing the trajectory of the SHSE Composite Index: (i) a power-law relaxation and (ii) log-periodic undulations. A combined log-periodic power-law (LPPL) analysis in Section 4 further confirms the existence of an antibubble in the Chinese stock market. We test in Section 5 the predictive potential of our characterization of an antibubble regime. Section 6 compares the 2001 China antibubble with other documented antibubbles and describe how the antibubble was gestated and how it developed. Finally, Section 7 concludes.