After the Chinese stock crash: Why a recovery may be imminent

Chinese stocks are certainly going through tough times at the moment. To date, the FTSE China 30/18 Capped Net Index, a broad-based stock index, has lost nearly a quarter of its value. It’s also down more than 40% from its all-time high less than a year and a half ago.

However, for investors who are able to take a longer-term perspective, we believe it is worth putting the situation in some context.

One of the biggest drops in over 20 years

We all know the past cannot predict the future, but that shouldn’t stop us from consulting the past to gain some insight into the future. The current pullback is interesting from an analytical point of view. We have examined previous examples of market retracements of 10% or more from the previous peak. Between 2002 and 2021, there were a total of nine cases of declines greater than 10%.

Four of these cases experienced losses in excess of 20% and three cases experienced market losses in excess of 30%.

With the exception of the crash that occurred during the global financial crisis, we are currently experiencing the largest decline in more than twenty years. The losses exceeded the bursting of the speculative bubble in 2015/2016 (-40.8%) and the shocks from the Trump trade war in 2018 (-30.4%).

At the same time, keep in mind that given the current volatility, an index value higher or lower by 10% is almost meaningless for long-term investors.

Typical example:

From mid-March 2022 to early April, the index rose by about 25%, followed by a 16% decline at the end of April. Just one week later, the market was up 10% again.

Those are impressive numbers, and a recovery of another 10% or so from today would bring the market back into “normal” historical decline territory.

Recovery delayed based on past market behavior

Perhaps more interesting than the depth of the valley is the time between high and low, or in other words, when do things usually improve? There is good news and bad news. The bad news is that the current misery has lasted longer than any other condition in the past. The good news is that by following the same logic as the past, a major rebound has been missed. In the nine cases mentioned above, the cycle floor occurred on average after about 22 weeks. Not surprisingly, the deeper the loss, the longer it usually takes the market to reach the bottom. But even during the financial crisis, when losses far outstripped today, it took about 53 weeks – about a year – for stock markets to reverse. In this last cycle, the temporary bottom was reached after only 62 weeks. This may indicate that we are going backwards.

Any new lows from this point could make the current loop anomaly (albeit statistically insignificant given the small sample size).

In short, while the current situation is certainly one of the steepest bear markets for Chinese stocks in the past 20 years, it’s also not unique.

Since we have seen at least two events of world-changing proportions since 2020, the Covid-19 pandemic and the Russo-Ukrainian war, as well as domestic problems in China, one could perhaps argue that the market has shown relative resilience. This will offer little consolation to investors who are suffering heavy losses. However, for those who are able and willing to move beyond short-term volatility and who believe in the long-term underlying condition of Chinese stocks, this may put the current situation into perspective.”

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