A Bull Market in Shanghai

Ichiro Suzuki

Shanghai has hit its ten-year high, a headline read in mid-August. After a series of uninspiring and sometimes depressing developments, the Shanghai Composite Index rose to where it has never been in the last ten years. That’s a very good news. Here’s a bad news, on the other hand. It is still 40% below its all time high in October 2007. Amid hypes of a rapid ascent of the Chinese economy back then, the Shanghai market hit its peak, ten months before the Olympics in Beijing. 

1n the roaring 1920s, Wall Street experienced a spectacular bubble. The Dow Jones Industrial Average soared in frenzies, reaching a dizzying peak in September 1929. Then, the Dow suffered an epic decline in the next three years, losing almost 90% of the peak value. Real estate prices collapsed and business failures ballooned, taking the banking system down with it. Unemployment rose sharply while demand tanked, leaving vast idle capacity throughout the manufacturing industries. Franklin D. Roosevelt made an attempt to create demand with massive injection of taxpayers’ money into the economy. Whether New Deal succeeded in lifting the ailing U.S. economy or not is debatable. Ultimately, it was WWII that gave a big boost to the economy. ‘Mobilization’ filled factories’ production lines for weapons and military equipment of all kinds and unemployed people found a job at factories. FDR did cleaned up the damaged banking system, with new regulations that laid groundwork for economic expansion down the road. Leaving the gold standard was a right move to weaken the dollar and increase liquidity though the Fed made a mistake of raising interest rates at the outset when the economy was sinking into a deep recession. In November, 1954, a quarter century after the peak at the end of the booming twenties, the Dow Jones Industrial Average rose to a fresh new high. 

In February, 2024, Japan’s Nikkei Average rose to a new high, 34 years and two months after the infamous bubble’s peak, taking nine years longer than the Dow over seventy years ago. Unlike the Dow, the Nkkei had to do it in peace time, without demand boost from a world war. The bubble in the 1980s was driven by real estate that immediately spilled over to the stock market. Ultra low interest rates, by the standards of those days, drove asset prices to unsustainable levels. The bubble’s excess was characterized by land value of the Imperial Palace in Tokyo that was said to have matched that of the State of California. The Bank of Japan moved aggressively to contain inflation in asset prices as well as goods and services. The move worked but proved to be costly. The banking system, which lent aggressively to developers, went down in the real estate market’s collapse. Unlike FDR’s White House, the Japanese government hesitated to move boldly, for fear of voters’s resentment against bailing out banks with taxpayers money, with a vague hope for the market’s rebound. Not surprisingly, hoping wasn’t a right strategy. The Japanese yen remained vastly overvalued while the economy was falling apart, in contrast to the U.S. in the 1930s that devalued the dollar. Even worse, Japan’s electronics and semiconductor industries began to lose competitiveness, falling from world-leading positions. Fall of these industries aggravated Japan’s setback. 

China’s rise in early years of the 21st century drove the global economy. Rise of the Chinese economy was also driven by a phenomenal real estate boom, not surprisingly. The economy rose in a spectacular fashion, lifting demand for office space and land for factories. Rising income boosted demand for houses. Newly built highways and high speed train networks contributed to greater productivity, too. 

As soon as the Shanghai market rose to the level never to be seen since then, the Great Recession hit the global economy, with the severest banking crisis in over seventy years. Bank CEOs in the U.S. and Europe who were suffering from acute capital shortages begged China to inject capital into their balance sheets that were sinking into a deep hole, but China didn’t respond to such requests. Amid a sharp decline in its export markets, the Communist Party came up with a huge infrastructure investment program to provide demand to the ailing global economy. It was China’s moment. Without that fiscal stimulus, the global economy would have found it harder to bottom out. The success story, however, taught the Party a wrong lesson. On every slowdown in the economy since then, the CCP came back with more infrastructure projects. At some point, the Chinese economy came to a point where another highways and railways didn’t contribute to greater productivity. Not surprisingly, house prices also reached a point of not going further up. While the economy no longer grew at double digit rates, industrial capacity failed to adjust to the new normal in the 2010s. Excess capacity in steel and other basic materials became harbingers of mild deflation. 

The pandemic at the outset of the 2020s caused a downward shift on the Chinese economy, along with those elsewhere. The U.S. rebounded more quickly and strongly from the COVID 19 recession by choosing to live with the pandemic to a certain extent rather than extinguishing it fully. China chose the latter path by confining its population under severe lockdown. An aggressive fight against the coronavirus weakened the real estate market even further, on deterioration of potential buyers’ income. Feeble demand for apartments pushed over-leveraged developers to the corner. On August 25, 2025 it culminated in eviction of Evergrande from the Hong Kong Stock Exchange. Its peak market capitalization of $51 billion fell to as close to anything as nothing. The developer’s $150 billion bonds outstanding were almost fully wiped out. Half way finished housing projects are left as they are. Those who made downpayment are stuck with their unfinished apartment units. Deteriorated household sector balance sheets aggravates downward pressure on the economy. Of course, Evergrande isn’t the only developer caught in this nightmarish situation, and this is a Chinese economy-wide problem. As defaults of Evergrande bonds show, much of these developers’ reckless projects were financed by bonds, thus spreading financial risks among a many investors, unlike financing through bank loans that concentrate risks in a smaller number of lenders. Because of this financing practice, China’s banking system seems uniquely stable, a great deal more stable than the U.S. in the 1930s and the 2000s and Japan in the 1990s. In the absence of a severe banking crisis, unfinished housing projects still hang on the Chinese economy. Someone has to take over the projects to finish them and then deliver them to those who paid for them. And no one else other than the public sector is capable of doing it. 

Last decade, the Communist Party laid out a slogan “Made in China 2025” having been aware that growth model dependent on real estate and infrastructure projects went as far as they could. Renewable energy and electric vehicles have been designated as the industries of the future. Then massive subsidies have flowed into these industries. The strategy has proved successful, driving both of these industries to lead the world. They took off, however, at the expense of profits. Subsidies expanded capacity rapidly and subsidized consumers responded to it. While China is the front runner in EV innovation, car makers aren’t generating profits. Products cranked out of excessive capacity is cost competitive, but flooding the market with such products raises eyebrows not only in the developed world but also in countries that are under China’s orbit. The second largest economy is supposed not to try to grow on exports of subsidized industrial products. Xi Jinping, however, has no grasp of what’s wrong with providing consumers in the global markets with low priced goods with reasonable quality. 

The price China is paying for this growth strategy is failure to create wealth. It is most prominently displayed in the lackluster stock market. The ratio of equity market capitalization to GDP stands at 70% for China whereas it is 220% for the U.S. and 170% for Japan. The U.S. and Japan may be overvalued but China isn’t receiving higher valuation for reasons. Household sector balance sheets remain impaired. Subsidies in the absence of profits will not keep the economy going indefinitely. While Donald Trump is beginning to meddle in the private sector, the U.S. distinctly remains an economy driven by free enterprise. It is possible that the Shanghai market rises to rewrite the high within six years, a quarter century or less after the dizzying peak that stands since 2007. There is, however, a question if the market keeps rising beyond that point for a new age of Chinese equity investing. For the market to keep going, China has to leave the plaguing problems behind, and Xi Jinping has to understand why exporting inexpensive goods without profits isn’t a right strategy. 

About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.