Evan Soltas
Aug 31, 2015

A Fact about China's Crash

Imagine I took all the stocks in the Shanghai index on June 11, 2015, the height of the bubble in Chinese equities, and created 50 different investment portfolios.

Portfolio #1 would invest only in those stocks that had cumulatively performed worst since March, roughly when the boom began. Portfolio #2 would invest in stocks that had performed slightly better, and so on until I had broken the whole index into 50 portfolios, with the very last portfolio invested in the stocks that ran hottest in the boom.

The performance of those portfolio since June shows a clear pattern, and a very familiar one to students of America's housing bubble and bust. The bubbliest portfolios, and the bubbliest stocks have performed the worst amid the crash -- just like Las Vegas in 2005 versus in 2009.

What went up, in essence, is now coming down. This graph shows that fact.

Indeed, this "what goes up must come down" result is so strong that it explains a third of all cumulative returns of individual stocks, and virtually all of the cumulative returns of the portfolios, over this period. (This statistical performance compares favorably to most tests of the CAPM or the Fama-French 3-factor model on US equities.) About half of all the bubble-related gains, from this perspective, have been unwound.

One shouldn't infer directly from this that the crash is "good." But, if you thought that the boom was nuts, you might be relieved to know that the crash is quite focused on undoing the boom and isn't just dragging everything lower.

This post would not have been possible without help with Python from my friend Evan Chow. Evan helped me scrape Yahoo Finance for individual .csv files from the Shanghai index. I wrote a Stata program to merge the files together into a single panel dataset and completed the analysis.