As we moved past the significant date of September 24, discussions around a potential bull market began to swell across financial platformsInvestors, analysts, and media outlets shifted their beliefs, heralding what they perceived as the end of a prolonged bear marketHowever, this sentiment faced a reality check following the market's jarring movements on October 8, where sharp declines led some to argue that this might merely be a temporary bull phaseSubsequent remarks by the central bank on October 18 reignited fervor, evoking claims that the bull had indeed returnedYet, this fluctuation in market sentiment leaves us pondering: how should we accurately interpret these cycles of bulls and bears? It’s clear that mere emotional impulses cannot be the sole determinerA deeper dive into external analyses reveals the pressing factor of debt, crucial in delineating the landscape between bullish and bearish tendencies

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It is an angle worth contemplating deeply, as it has proven to be a blind spot for many investors.

Over recent days, prominent figures in finance, such as Ray Dalio of Bridgewater Associates, have reiterated an emphasis on the significance of debt in understanding market fluctuationsDespite Chinese economic growth exhibiting a commendable double-digit nominal rate over the last decade, the returns from the stock market have lingered close to insignificanceCurrent metrics as represented by indices like the MSCI China Index reflect a staggering drop, nearly 50% from its pre-pandemic peak at the beginning of 2021. For the 2024 fiscal year, GDP growth forecasts signal a downward trajectory: an estimated 5.3% year-on-year for Q1, followed by a decline to 4.7% in Q2 and 4.6% in Q3. To achieve an annual target of 5%, Q4 is projected to require a growth rebound to 5.4%, leading to imminent and robust monetary stimulus.

In one of Dalio’s insightful proclamations about the Chinese market, he emphasizes the substantial burden of debt that local governments are currently shouldering

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Historically, these regions financed their operations through land sales and borrowingHowever, this model is now falteringParticularly illustrative of this is the real estate sector, which is characterized by over-leveraging, with the Evergrande crisis epitomizing a fraught addiction to growth without a sustainable foundationHe stresses the necessity for the central government to step in with financial support for provinces, a demand certainly evident in current fiscal policiesBut he also points out that a restructuring of these provincial debts is vital.

The task ahead is framed by two essential actions: the first involves debt restructuring along designated lines; the second pertains to monetary policy, where interest rates must remain below nominal growth ratesFurthermore, Dalio recommends that real interest rates stay low while proposing methods to limit the propensity to save

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In the global perspective, debt risk clearing stands as a critical determinant in establishing a bottom in asset prices.

This preoccupation with debt is not merely a theoretical exercise but rather rooted in empirical evidence observed internationallyHistorical data has shown that protracted downturns in stock markets strongly correlate with high leverage and debt issuesOnce rates of expansion fueled by overly lax monetary policies reach their pinnacle, central banks often find themselves compelled to raise rates to temper overheated markets, resulting in a deflation of financial bubblesWhen corporate and household debt levels become precariously elevated, the correction often culminates in significant drops in asset prices, leading to a reduction in consumer confidence and plunging economies into what is termed 'balance sheet recessions.'

In the last phase of a deflationary debt cycle, signs of economic vitality and renewed capital formation can become visible; however, this revival typically unfolds over a span of five to ten years before reattaining peaks witnessed in the past

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According to Dalio, bull markets are often birthed amidst financial bubbles, whereas the foundation for a major market bottom is frequently laid during periods of economic downturnTo chart a clear inflection point for asset prices, we must witness a significant reduction in leverage levelsIn instances where risks associated with debt are only partially addressed, the established bottom could be at risk of being breached, plunging the market into yet another cycle of downturnThis pattern is notably evident in Japan’s experience through its lost decades, during which multiple rebounds exceeding 50% occurred without fully escaping the bearish grips.

Ultimately, if market declines transpire while leverage remains elevated and insufficient debt resolution manifests, the potential for further downward breaches looms largeDrawing parallels to the 1990s in Japan, the apex of asset price inflation led to the Bank of Japan’s aggressive rate hikes, aimed at deflating the burgeoning bubbles