Chinese Stocks during 2000–2013: Bubbles and Busts or Fundamentals?

Abstract

Although the Chinese economy has weathered the recent global financial crisis well, Chinese financial markets performed poorly from late 2007 through the end of our sample period in 2013. This apparent disconnect between measured economic fundamentals and stock market performance has attracted considerable attention. However, it is important also to investigate whether this disconnect is only short-term with macroeconomic variables continuing to have important equilibrium relationships over the longer term. This article uses a multivariate cointegration and vector error correction model to test whether domestic macroeconomic fundamentals are important forces in explaining Chinese stock fluctuations. Test results show that economic factors in China have a long-term equilibrium relationship with stock market performance. Stock prices responded consistently negatively to changes in the real exchange rate during 2000–2013. After the Chinese stock market crashed in 2007, stock variations became more responsive to changes of economic fundamentals suggesting that there had been a bubble. Policy-driven factors, such as bank deposits and bank loans, had strong impacts on stock performance. Real economic factors, such as industrial production and exports, also became significant in explaining Chinese stock returns, but their economic impacts were smaller.

Keywords:

• financial and economic policies
• VECM
• China
• stock performance
• bubble
• macroeconomic fundamentals

Notes

We used the Shanghai Composite Index because it represents large enterprises. Another national stock index, the Shenzhen Composite Index, represents smaller, younger, and privately owned companies in China.

See also Burdekin and Redfern (2009) on the relationships between the stock market and savings deposits at this time.

We refer to appreciation as an increase in the exchange rate.

Note that under flexible exchange rates, there is no a priori expected relationship as the correlations should vary with the type of shock. For example, a development that increases the outlook for the economy would likely increase both the exchange rate and the value of the currency. With a fixed rate, revaluations are at least partially exogenous in the short run and, thus, we would expect normally to see a negative correlation which is what our results indicate.

For analysis and references to debate over China’s exchange rate policy see Sinnakkannu 2010 and Willett, Ouyang, & Liang 2009.

For example, since mid-September 2008, China cut the preferential housing mortgage rate five times to boost the economy. On October 22, 2008, China announced a series of policy changes for the same purpose: lower mortgage rates, reduced down payments, lower transaction taxes. On November 7, 2008, China announced a 4 trillion yuan stimulus package. A tenth, or 400 billion yuan, is to be used on construction of affordable housing. On December 17, 2008, China announced measures to support the property market, including cuts in business and transaction taxes for real estate sales, and policies to make it easier for developers to obtain credit (Reuters 2010).