Interesting reading here from BNP on the potential of another Chinese stock market crash. Their approach is interesting as they come to their conclusions using components of the same theories that make up my own work. I, however, do not believe the Chinese market is in for a crash, but rather believe the “long decay” scenario is far more likely. It would be highly unusual for two bubbles to form in the same market in such a short period of time – especially when the fundamentals and psychology of the market’s participants don’t justify it. In fact, it could be called an anomaly since it has never happened before. Not to mention the fact that we are nowhere near the stampeding euphoric sentiment that always accompanies a bubble:
Amid the current financial crisis, there has been one equity index beating all others: the Shanghai Composite. Our analysis of this main Chinese equity index shows clear signatures of a bubble build up and we go on to predict its most likely crash date: July 17-27, 2009 (20%/80% quantile confidence interval).
It must be noted that the model gives no indication on what happens after the critical point. It tells us the rise will end, but that might be with a crash or a slow decay.
By the very nature of the model, this result gives us two conclusions. Firstly, there exists a bubble in the Shanghai Composite Index. Secondly, it will reach a critical level around July 17-27, 2009. This will lead to a change in regime which may be a crash or a more gently bubble deflation. An extended version of this note, with a careful assessment of the confidence intervals and comparisons with the previous Chinese bubble ending in Oct. 2007, will be released soon.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.