Shi Donghui, professor of finance at the School of International Finance, Fudan University
The stock market turmoil that began late last year and ended at the beginning of this year has come to an end, but the resulting series of strict regulatory policies will have a profound impact on the development of China's capital market in the coming years. In recent years, there have been many one-sided views in the discussion around the development of the capital market. These views, which seem reasonable on the surface, are in fact confusing and cannot stand up to scrutiny, so it is necessary to clarify the truth and clear the fog.
01
Fallacy 1:
A sharp drop in stock prices can trigger a financial crisis
Whenever the market plummets, a popular saying is that a sharp drop in stock prices is likely to trigger a financial crisis and systemic risks, so the call for a bailout is rising, and various strong regulatory policies are urgently introduced. Is that really the case?
Examining the history of the development of the financial markets at home and abroad, it can be found that the sharp decline in the stock market does not necessarily lead to systemic financial risks and crises, and financial turmoil and crises will only be triggered when financial institutions, especially commercial banks, are deeply involved in the stock market, or when the stock market has a high degree of capital leverage.
In the former scenario, the bursting of stock market price bubbles often triggers debt defaults, erodes the balance sheets of the banking system, and leads to large-scale failures of systemically important financial institutions, leading to the spread and spread of systemic financial risks. Japan's bubble burst in the early 90s, the Asian financial crisis in 1997, and the subprime mortgage crisis in the United States in 2008 are all typical cases. In these cases, the funds of commercial banks and other financial institutions flowed into the stock market on a large scale through self-operated and pledged financing, and when the stock price plummeted and the bubble burst, the financial institutions were forced to sell a large number of dollars in the market due to liquidity pressure, resulting in the spread of panic and the accelerated decline of stock prices, posing a direct threat to the health of the institution's balance sheet, and in severe cases, triggering the collapse of the institution and the occurrence of a crisis.
The second scenario is that there is a widespread phenomenon of increased leverage in the market, where participants are highly leveraged, and when the stock price falls sharply, the selling and closing behavior of investors causes the stock price to fall further, which in turn leads to a wider and more violent selling and closing behavior. When this "liquidity spiral" develops to an extreme, there will be a dilemma in which the market liquidity crisis and the investor liquidity crisis will magnify each other. A typical example is the bubble and collapse of the U.S. stock market in 1929, when the popularity and widespread use of credit cards increased the purchasing power of the middle class, promoted leveraged trading in stocks, and greatly contributed to the boom of the stock market. And when stock prices fell sharply, people rushed to sell, shaking the then unstable financial structure and banking system, leading to the "Great Depression" in the Western world. In contrast, the U.S. dot-com bubble at the end of the last century, despite its equally staggering drop in stock prices, was only a few months after its bursting into a mild recession due to relatively low financing transactions and leverage, and did not have a long-term negative impact. As former Fed Chairman Alan Greenspan later said, "We all know there are bubbles, but the bubbles themselves don't bring you a crisis." It turns out that it is a bubble with leverage that leads to a systemic financial crisis. ”
It can be seen that the relationship between the stock market crash and financial stability cannot be generalized, and the key lies in whether there is deep involvement of funds in the banking system and the degree of leverage of participants. The mainland should also strictly guard against the resurgence of leveraged funds and over-the-counter capital allocation, and ensure that the market does not suffer from irrational spikes and plummets due to highly leveraged trading behaviors, which will affect the stability of the financial system.
02
Fallacy 2:
A sharp rise in stock prices will have a wealth effect
In recent years, whenever the economic operation is facing a contraction in domestic demand and weakening expectations, there are always people who advocate stimulating the rise of the stock market through the so-called "favorable" policies and creating a bull market, hoping to promote consumption and stimulate investment through the appreciation of residents' stock assets. This suggestion seems reasonable, but in fact it does not stand up to scrutiny, and even in the case of the United States, which has the most developed capital market and has the greatest impact on economic operation, only weak evidence of wealth effect has been found.
The wealth effect seems intuitively a self-evident phenomenon. However, such a broad theoretical concept is not a substitute for the actual empirical relationship between consumption and changes in wealth. A study of stock market gains and losses and consumption changes in 14 major developed countries by the Yale Cowles Foundation found only weak evidence of the wealth effect of stock markets.
For example, the level of wealth in the United States has continued to soar, driven by a strong stock market, with household financial wealth rising to nearly $49 trillion in the first quarter of 2023, but the consumption rate (the ratio of consumer spending to disposable income) has not increased significantly, but has fluctuated horizontally, and the wealth effect seems to have disappeared.
The root cause of the gradual disappearance of the wealth effect may be that income and wealth are increasingly concentrated in the hands of high-income people, and the richer people tend to have a higher return on investment. According to the latest statistics from the Federal Reserve, the top 1% of households in the United States own 53% of the market value of stocks, and the top 10% own 88% of the market value of stocks. Wealthier households have a lower propensity to spend and higher savings rates, which pushes up the average savings rate and inhibits the increase in consumption rates. Stock market surges often become a "feast" for the few, with the result that the gap between rich and poor has increased and polarization.
Since its birth, China's stock market has also experienced many rounds of bull and bear replacement, and the stock market has also stirred people's hearts, but whether it is the Internet stock frenzy caused by the 5.19 market, or the resource stock bubble that emerged in 2007~2008, or the "Internet + GEM" bubble in 2015, or even the track stock boom caused by fund group consumer stocks and new energy stocks, each short boom is a "chicken feather", most investors have suffered heavy losses, and the "wealth effect" is lackluster. Favorable policies introduced to stimulate the capital market are often taken advantage of by market speculators, and become the beginning of market speculation and a new round of "cutting leeks" game, and finally leave the regulators and investors with a devastated market.
It can be seen that the suggestion of creating a bull market to stimulate demand is not tenable in theory and is not feasible in practice. Overemphasizing the counter-effect of the stock market on the economy is undoubtedly a suspicion of putting the cart before the horse.
03
Fallacy 3:
IPO expansion was the main reason for the market crash
Research in the field of behavioral finance shows that investors in the stock market have a strong tendency to self-attribute, when the stock market rises, everyone thinks that they are the god of stocks, and when the stock market falls, they regard themselves as victims and blame others for their mistakes. The decline of the market is violently fed back to the regulators in the form of public opinion, and the regulators often make an anti-market policy choice at the wrong time in this environment, resulting in swings and deviations in the positioning and intensity of supervision from time to time.
From the analysis of economic theory, only the price of risk-free assets (such as consumer goods) depends on supply and demand, and stocks, as an investment product, are a risky asset. According to the principle of high risk and high return, low risk and low return, the price of investment products only depends on the level of risk. The higher the risk, the higher the risk premium and the lower the price at which it is discounted. As a result, the price of an investment is inversely proportional to its risk. In the pricing relationship of risk assets, it is the price that determines the supply of funds, not the supply of funds that determines the price. This is quite different from the common sense we get from the pricing of consumer goods.
If the stock market is analyzed according to the nature of the above-mentioned investment products, then the intrinsic value of the stock market is based on the equilibrium relationship between various types of risk assets in the domestic market. The fundamental reason for the decline of the stock market is not the expansion of IPOs, nor the short selling and reduction of holdings, but the excessive speculation of investors on the market as a whole or some important sectors, resulting in excessive overvaluation of prices and bubbles.
04
Fallacy 4:
To improve the quality of listed companies, it is necessary to strictly control the "entrance gate" of IPO
The quality of listed companies is the foundation for the healthy development of the capital market. Based on the fact that the internal control mechanism of some enterprises to be listed is not perfect, the corporate governance is not standardized, and even the financial fraud of individual enterprises, all parties now generally believe that only "good companies" can be listed, so it is necessary to strictly control the entry of issuance and listing, and improve the quality of listed companies from the source. However, this basic perception may be wrong, which is also the root cause of the reform of the registration system.
Theoretically, in a marketplace with efficient pricing, both "good" and "poor" companies can be listed, but "good" companies can sell at a good price, while "poor" companies can only sell at a bad price, and even if a "poor" company is listed, it has little liquidity, so there is no strong incentive to go public. However, in a market with ineffective pricing, "poor" companies can sell at a good price and enjoy high liquidity, making the quality of IPO companies a major contradiction in the market, and the back-end delisting mechanism is also not working smoothly.
In the face of this situation and market concerns, the current policy choice of the regulatory authorities is to strengthen supervision in all links of the whole chain of issuance and listing, and strengthen the review of enterprises to be listed. For a time, the IPO issuance and listing seemed to have "changed", the declaration became more and more difficult, the review became more and more strict, and the "visible hand" of supervision once again strongly intervened in the market-oriented operation process of the registration system.
So, can strict IPO supervision really improve the quality of listed companies at the source? The answer is no. In theory, regulation is used to correct, not replace, market failures. In practice, the visible hand almost always steps on the invisible hand. In fact, in the past, the supervision of approval-based issuance was not strict, but strange phenomena still appeared frequently in the field of new share issuance and listing, resulting in a vicious circle of continuous patching of regulatory rules, continuous escalation of regulatory actions, and continuous expansion of regulatory costs.
The essence of the reform of the registration system is to change the basic relationship between the government and the market in the issuance of shares, and to "give the right of choice to the market." Just as you can't get a good body by taking medicine, the belief that the quality of listed companies and the efficiency of the capital market can be improved through various administrative supervision is to a large extent an illusion of administrative omnipotence derived from the dependence of the government's regulatory path. The regulatory authorities need to abandon the long-term inertia and path dependence of using administrative means to allocate and manage securities resources, change the concept and mode of supervision, and change the focus of work from pre-approval to regulatory intervention and post-event audit and accountability.
05
Fallacy 5:
To grasp the people's nature of the capital market, it is necessary to ensure that the index does not fall
Protecting the legitimate rights and interests of investors, especially small and medium-sized investors, is not only the regulatory mission of the capital market, but also an important embodiment of grasping the people's nature of the capital market. However, in related discussions, some people always consciously or unconsciously equate it with ensuring that the index does not fall, and the public opinion environment that uses the index to rise and fall has become the main factor hindering the healthy development of the market.
Stock investment is a complex economic activity with the participation of tens of millions of people, sharing high-growth opportunities for a few companies, and it is a process of big waves and sands. Even in the most successful U.S. stock markets, more than 90% of the value over the past 100 years has been generated by 2% of public companies, and the top three companies (Apple, Microsoft and ExxonMobil) have generated 11% of the total value of the stock market. In recent years, the continued rally in the U.S. stock market has also been driven by seven major technology stocks consisting of Facebook, Amazon, Apple, Microsoft, Google, Nvidia and Tesla. Investors should have a clear understanding of participating in stock market investment, and cannot unrealistically expect all stocks to rise and make a profit. The final result of market operation is inevitably that some people make profits and some people lose, some stocks rise and some stocks fall, this differentiation reflects the pricing efficiency of the market, and the general rise and general decline are the performance of the immaturity of the market.
According to the latest statistics of Zhongdeng, the number of accounts opened by individual investors in China's stock market has exceeded 220 million, and the annual transaction value accounts for about two-thirds of the total turnover of the Shanghai and Shenzhen stock markets. Looking at the global stock market, this market characteristic of small and medium-sized investors is the most significant "Chinese characteristics" of China's capital market. Therefore, we must recognize the characteristics of China's securities market that is still in its infancy, recognize the market structure with Chinese characteristics dominated by small and medium-sized investors, and recognize the differences of small and medium-sized investors as a vulnerable group.
Based on this special investor structure, protecting the legitimate rights and interests of investors, especially small and medium-sized investors, has become the top priority of the regulatory authorities, but this does not mean that the regulatory authorities can decide the rise and fall of the index. In fact, the rise and fall of the stock market is affected by various factors such as the international economic and financial environment, national monetary and financial policies, economic growth expectations, and market trading behavior.
The real duty of the regulatory authorities is not to ensure that the index does not fall, but to effectively safeguard the "three publics" principle of the market and effectively protect the legitimate rights and interests of investors from four levels: first, to ensure that investors' shareholder rights can be fully protected; second, to ensure that investors' trading rights can be treated fairly; third, to ensure that major shareholders' violations of laws and regulations can be investigated and dealt with in a timely and effective manner; and fourth, when investors' legitimate rights and interests are illegally infringed, they can obtain convenient and effective regulatory protection and judicial remedies.
This article was originally published in China Business NewsSource: Fudan University of Finance