Can Bear Markets happen outside a Recession? China’s Shanghai and Bangladesh’s Dhaka Indices

While bear markets usually accompany economic recessions, the cause and effect does not always hold.

Proof?

The following is China’s Shanghai Index (Bloomberg)

The Shanghai composite melted away nearly one year ahead of the global collapse brought about by the Lehman bankruptcy.

Since October the peak of 2007, today, the SHCOMP still is about 60% off the peak.

Peak to trough, from October 2007 to October 2008, the major Chinese composite lost 70.6% in one year, which means that from 2008-2011, only 10% of the accrued losses had been recovered.

However, the resultant world economic slowdown from the Lehman episode only diminished China’s economic growth rate (tradingeconomics.com) but did not lead to a technical recession.

China’s economic growth rate peaked in 2007 at around 13% and bottomed at 6% in 2009.

That’s partly because of China’s humongous $586 billion stimulus program which temporarily shielded the economy but has led to massive malinvestments.

One would note that money supply incrementally grew (red lines) from 2005-2007, but accelerated when the enormous stimulus packaged had been unleashed.

What has been palpable was the growth had been in new loans (chart Guinness Atkinson), which seemed unaffected by the stock market crash.

However, the Shanghai Composite bear market began or coincided with the regime's monetary tightening.

Bank reserve ratios had been serially increased, aside from interest rates which rose in 2007 until February of 2008. (chart from IMF)

However as noted above, the stimulus only prompted speculation to shift money from the stock market towards real estate (see below)

Yet the Chinese government has been attempting to contain the ballooning bubble via the same tools it used against the stock market plus some additional features as financial markets worked around government regulations.

Again from the IMF, (bold emphasis mine)

The central bank has used both reserve requirements and higher interest rates to slow credit but still relies heavily on direct administrative limits on loan growth. The central bank has also introduced a supplemental “dynamically differentiated reserve requirement,” which varies across banks and through time based upon the pace of credit growth at the bank, the capital adequacy ratio, and other factors. Staff argued that this focus on quantity limits has limited the supply of bank credit but with little impact on the cost of capital or demand for new loans.

In addition, with guaranteed loan deposit rate margins, the banks still have strong incentives to expand lending. As a result, the control of monetary aggregates through direct limits on bank lending is already being disintermediated. There has been a significant rise in off-balance sheet provision of loans (e.g. through trust funds, leasing, bankers’ acceptances, inter-corporate lending, and other means) and a growing intermediation of credit through nonbanks and fixed income markets. In addition, over the past several months, there have been large loan inflows from offshore entities recorded in the balance of payments (as Chinese companies go abroad to offset credit restrictions at home). Such avenues were already partially counteracting the impact and effectiveness of monetary tightening and that tendency was likely to increase in the coming years.

The central bank indicated that it was committed to moving gradually to more price based tools of monetary policy, noting that loan and deposit rates had been increased four times since October. The central bank was also now monitoring a broader measure of “social financing”—which includes bank loans, off balance sheet lending, as well as funds raised in the equity and bond markets—in order to better judge financial conditions. They felt that the existing array of tools and the expanded scope of their surveillance would be sufficient to contain disintermediation risks. They also indicated that, to some degree, lending limits could be viewed as an effective microprudential device in a system where risk management and risk monitoring were still insufficiently developed.

The rise of off balance sheet financing would be symptomatic of what Hyman Minky’s would call as speculative financing of a credit cycle. This would somewhat replicate the role of the shadow banking system during the US mortgage crisis.

Bottom line: China’s continuing bear market has been a product of her government’s boom-bust policies.

One more example:Bangladesh

Bangladesh recently experienced a stock market crash that seems detached with the actions of global markets.

The Dhaka index still remains in a bear market since its apex in December of 2010… (Bloomberg)

…but there has been no signs of economic recession (tradingeconomics.com) accompanying the bear market

The apparent reason seems to be same: The reversal of the Bangladesh government’s previously induced boom policies with policy tightening that resulted to a stock market bust.

See my earlier explanation here

Depending on some other factors such as depth or penetration level of local investors on the domestic stock market or for other more reasons, actions in the stock markets can occasionally be detached from the real economy.

Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets

Here is more proof that stock markets around the world have been mainly propped up by inflation (bank credit expansion)

If you recall, we earlier noted that the stock market of Bangladesh (Dhaka Index) posted as the second best performer in the world in 2010 gaining nearly 83%.

Chart from Bloomberg

Yesterday fortunes seem to have reversed, as the Dhaka index suffered a record crash. This provoked street riots and prompted for the forced closure of the exchange.

Picture from Marketwatch.com

According to Sify News

Stock exchanges in Bangladesh were forced to close down for the day Monday after share prices registered their biggest fall ever and investors took to the streets.

Angry investors vandalised some vehicles and set fire to tyres as they demonstrated in Motijheel area in the heart of the national capital.

People have been lured by easy money where “over three million people - many of them small-scale individual investors” had been affected by the crash, according to a BBC report. A crash reportedly brought upon by a “series of measures” implemented by authorities to restrain “overvaluation”.

Here is a short BBC report…

The series of measures involved the raising of the cash reserve requirements for banks…

From AFP

On December 15, the Bangladesh Bank had raised the cash reserve requirement (CRR) by 50 basis points, tightening money supply in a bid to rein in soaring inflation.

Analysts, protesters and the SEC say this is what triggered the collapse as some banks, which had invested heavily in the market, tried to offload their shares quickly in an attempt to meet the new requirements.

and the curtailment of industrial loans that was being diverted into the stock market.

From Sify news

The limit for giving loans by the banks to their subsidiary companies was set at 15 percent of their total capital, but many banks invested more than the threshold only to increase their stakes in the capital market. BB had earlier directed the banks that invested more than the ceiling to adjust the excess amount by December 31.

Also, the central bank set January 15 as the deadline for the banks to recover loans taken by borrowers as industrial credit but were diverted into the share market.

And as Austrian economist Fritz Machlup correctly postulated

``If it were not for the elasticity of bank credit, which has often been regarded as such a good thing, a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and current amortization allowances is fairly inelastic, and optimism about the development of security prices would promptly lead to a "tightening" on the credit market, and the cessation of speculation "for the rise." There would thus be no chains of speculative transactions and the limited amount of credit available would pass into production without delay.”

Bank credit expansion plus retail investor euphoria seem as prima facie evidence of the Boom Bust cycles brought about by easy money policies.

Snap Shot of Asian Bourses

So how have Asia's equity benchmarks been performing of late? All charts from Bloomberg.com

For the major ASEAN markets (Malaysia's KLSE-blue, Philippine Phisix-green, Thailand's Seti-yellow, Indonesia's JKSE- orange), we notice some consolidation or possible indications of a "bottom" formation.

For South Asia, only Pakistan's Karachi 100 in green remains visibly weak while the rest seems to be in rangebound. India's BSE 30 (yellow) appears to be drifting at the near lows. On the other hand, Bangladesh's Dhaka in orange and Sri Lanka's Colombo in Blue seem significantly off their lows.

The industrialized export driven economies of Asia seem mostly coasting along the lows (Singapore's STI-blue, Taiwan's Taiex-green and Nikkei-yellow). Only crisis stricken Korea (orange) seems to have improved substantially.

Finally we see contrasting performances in Australia's S&P ASX 200 (green) also wafting near the lows while New Zealand's NZ 50 seems to be testing its resistance level.

Overall, performances have been mixed albeit those with less exposure to global ex-intraregion trade appear to be performing better.