Mr. Shangkong

Can bull or bear markets be more predictable?

China must adjust the economic structure as soon as possible. Failing to do so would result in "a lost decade" for the world's No.2 economy, says Edward Ding, chief economist for China Merchants Securities

PUBLISHED : Friday, 12 October, 2012, 4:02pm
UPDATED : Monday, 30 May, 2016, 5:00pm

Can we be more precise predicting the next bull or bear market? From a macroeconomic perspective, the answer is yes.

China has experienced roughly three main business cycles, up and down, since 1992, and Edward Ding, chief economist for China Merchants Securities, said in a new research report that there is a definite relationship between business cycles and stock market performance.

Using the Hodrick-Prescott (H-P) filter model, which is popular among many investment bank analysts, Ding noted that when the positive output gap (see dark red line in Figure 1) began to shrink, the country’s economy also started to contract (see Figure 1, in two-stage division) or was already in a recession (four-stage division) and such trends often indicated that a bear market was not far away.

Judging from the right end of the curve (also Figure 1), we currently have a negative output gap of two percentage points, given the 7.6 percent year-on-year GDP growth in the second quarter of 2012, Ding noted.

Based on the H-P model, China’s current economic state is even more critical than during the 1997 Asian financial crisis and the 2008 US subprime crisis, Ding said in the report.

While predicting bull or bear markets might make some people heave a sigh of relief, perhaps the real question is much tougher: How does China extricate itself from a "bad business cycle" when its economic growth slows sharply or even shrinks?

The Chinese government has made 7.5 per cent annual GDP growth rate its official target in the country’s well-known 12th Five-Year economic plan and some economists have expressed concern that China's economic slowdown could be even worse than expected.

Ding noted in the report that only when the growth rate of fixed capital formation is assumed to be as low as 7 per cent or even 8 per cent, a positive output gap could emerge in 2015 or 2016.

From now on, China will have a negative output gap for at least three or four years, Ding concluded. If the fixed capital formation growth rate remains above 10 per cent, China will have an increasingly serious problem of excess capacity and a negative output gap, he said in the report.

“China has no other choice but to adjust the economic structure as soon as possible. Failing to do so would result in ‘a lost decade’ for China,” he said.

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