The bull-to-bear stock market transformation is an inevitable trend during the rebalancing of the global economy. In recent years, the global economic balance has been worsening as reflected by the ever-increasing U.S. trade deficit and emerging economies' ballooning trade surpluses. During this period of imbalance, global capital markets have enjoyed brisk growth. From 2005 to 2007, the American S&P indexes, the MSCI Emerging Market Index and the Chinese Shanghai Composite Index soared 22 percent, 52 percent and 324 percent, respectively.

Since early this year, the global economy has entered a rebalancing period along with the bursting of the U.S. property bubble, suppressed U.S. consumption and dwindling exports from emerging markets. China's economic slowdown and the decline of company profits are mirrored in the midyear reports of listed companies. Meanwhile, declining exports also have eased the pressure for the appreciation of the Chinese currency.

The rebalancing period will last for at least a year. But when will it end? The U.S. property price readjustment and trade deficit readjustment are two major indicators. Compared with the peak in 2006, home prices in the United States have fallen by 26 percent. We expect them to fall a further 10 percent until next year. The world economy will not be revitalized until the U.S. property market stabilizes.

Dealing with a slowdown

The biggest threats to China's economic growth are inflation and shrinking exports due to weak international demand. In the second half of this year, the inflation rate dropped after reaching a peak, and sinking external demand led to a further decline in exports. In the meantime, real estate investment, another major driver of economic growth, has been falling. Since August, property prices in 70 large and medium-sized cities monitored by the National Development and Reform Commission dropped month on month. The number of cities experiencing falling housing prices increased to 25 in August from five in April.

Once prices fall, the public's expectations will be reversed. Because current property prices are still unaffordable for many, home prices will continue to fall. We estimate that in the next two years, the average home price in China will drop 15-20 percent. Meanwhile, the real estate investment growth rate will plummet considerably. CICC real estate analysts believe that the growth of fixed-asset investments in real estate will fall to 5 percent from this year's 20 percent, directly dragging down GDP growth by 1.3 percentage points. GDP growth will be further dampened by the sluggish construction material industry.

As a result, we expect, if the policy does not change, that China's GDP will grow 10 percent in 2008 and 7.3 percent next year, while the inflation rate will stay at 6.5 percent and 2-3 percent, respectively. This might indicate a soft landing for the Chinese economy that will be maintained within a safe range because of our consumption structure and positive fiscal policies.

In terms of monetary policy, we assume that China will enter a cycle of interest rate cuts. We expect the benchmark loan and deposit interest rates in the next 12 months to be slashed 81-135 basis points and 27-81 basis points, respectively, to encourage investment and consumption. We also expect that the reserve requirement ratio (money that lenders must put into the central bank) to be cut 350-550 basis points; and the renminbi to appreciate by a mere 2-3 percent against a basket of currencies.

But we believe that monetary policy will not make a huge difference. For one thing, the money supply will decline due to a weak economy and a lower trade surplus; for another, banks will become picky for fear that their loans will turn bad in a time of economic slowdown.

However, a readjustment in fiscal policy will actively propel economic growth. We expect that a value-added tax reform will take place as of January 1, 2009, capable of cutting the corporate tax burden by 150 billion-200 billion yuan ($22 billion-$29 billion). The total tax burden on individuals is likely to be further reduced by 50 billion-80 billion yuan ($7.3 billion-11.7 billion) because of a possible increase in the income tax threshold. The government might also issue more bonds to boost infrastructure construction and to offset the fiscal deficit.