Macro
Dealing with China’s Hangover – the sobering reality
I nearly got the date wrong on my comment – my goodness, it’s 2010! Happy New Year, everyone…
By my own-admission, the New Year’s Eve piece (China on Steroids, Japan on Hallucinogens) I wrote was a look at China through rose-tinted glasses. If you have not yet read this piece, I urge you to skim read it before reading today’s comment. Aptly written on the eve of New Year celebrations, it’s comforting to bask in the radiant glow of glorious China when the champagne is flowing and the fireworks are fizzing but, in the cold sobering light of the morning, the rhetoric must face the harsh reality of what lies ahead.
While I championed the tide of reform and investment that will undoubtedly occur in the financial services industry, it is this sector which also faces the most challenges. Firstly, in asset prices we have a huge conundrum in China, largely because we do not know exactly what is going on due to the opacity of data and the effects of government policy, on a central or local level. Bloomberg reported Fitch as implying that China Banks’ Capital Likely More Strained as the rating agency contemplates downgrades to the sector due to lack of transparency in the Chinese bank balance sheets as loan growth seems to be increasingly fueled by “off-balance sheet” transactions… hmmm… funny complicated products and a “growing pool of hidden credit risk” – I think we’ve heard that somewhere before haven’t we? There is no doubt in my mind that Non-Performing Loans (NPL’s) on bank balance sheets will rear their ugly head at some point over the next year or two.
Andrew Xie thinks that asset prices may rise in 2010 and hit new highs before being decimated on the jagged rocks of inflation in 2011. Granted, he’s been singing the same tune for a while now, but when I hear the theme repeating itself over and over again from different corners, it’s time to take a long hard think about it.
As many China property optimists cite, a large number of Chinese pay cash for homes or put down large cash deposits, this puts a degree of support to asset prices. But there is only so long markets can ultimately disassociate themselves from the reality seen by the overwhelming majority of the population, we found this out the hard way in the US. A fluidly constructed, Bloomberg article by Dexter Roberts has a few little hidden gems in it:
Millions of Chinese are pursuing property with a zeal once typical of house-happy Americans. Some Chinese are plunking down wads of cash for homes. Others are taking out mortgages at record levels. Developers are snapping up land for luxury high- rises and villas, and the banks are eagerly funding them. Some local officials are even building towns from scratch in the desert, certain that demand won’t flag. And if families can swing it, they buy two apartments: one to live in, one to flip when prices jump further.
Although parallels with other bubble markets, the China bubble is not quite so easy to understand. In some places, demand for upper middle class housing is so hot it can’t be satisfied. In others, speculators keep driving up prices for land, luxury apartments, and villas even though local rents are actually dropping because tenants are scarce. What’s clear is that the bubble is inflating at the rich end, while little low- cost housing gets built for middle and low-income Chinese.
In Beijing’s Chaoyang district, which represents a third of all residential property deals in the capital, homes now sell for an average of almost $300 per square foot. That means a typical 1,000-square-foot apartment costs about 80 times the average annual income of the city’s residents.
Chinese consumers, fearing inflation will return and outstrip the tiny interest they earn on their savings, have pursued property ever more aggressively. Companies in the chemical, steel, textile, and shoe industries have started up property divisions too: The chance of a quick return is much higher than in their primary business.
“When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land,” says Andy Xie, an independent economist who once worked in Hong Kong as Morgan Stanley’s top Asia analyst. “No one talks about their factories making money these days.”
The government is reluctant to crack down too hard because construction, steel, cement, furniture, and other sectors are directly tied to growth in real estate. In November, for example, retail sales of furniture and construction materials jumped more than 40 percent. At the December Central Economic Work Conference, an annual policy-setting confab, officials said real estate would continue to be a key driver of growth.
Analysts are divided over the probabilities of such a crash, but even real estate executives are getting nervous. Wang Shi, chairman of top developer China Vanke Co., has warned repeatedly in recent weeks about the risk of a bubble. In his most recent comments he expressed fear that the bubble might spread far beyond Beijing, Shanghai, and Shenzen.
Does this sound like sustainable asset growth to you – in real (inflation-adjusted) terms? In monetary terms, the demand may be genuine (while few alternatives exist for domestic investors in China), but, just like the fireworks and champagne on New Year’s Eve, it’s not a sustainable pleasure – what goes up must eventually come down, after the party comes the hangover – either in absolute terms or by inflation.
On his boxing day piece (The Pace of Change), Michael Pettis talks about the trade-off between social stability and change and it’s role in post-crisis liquidation. He differentiates between the US-style exit strategy (default and move on) and the Japanese model (zombie companies, slow grind) and the social implications of both. The reality is he’s talking about propensities to the velocity of money – or inflation. How China chooses to face the looming prospect of the deflation / inflation challenge is crucial to understanding the economic interplay in the region and China’s role in the Global Economy.
Macro Data to Watch:
- US housing numbers were OK last week but need to verify if this trend of improving employment will continue into the new year.
- Singaporean GDP -6.8% QoQ – oops, that was not expected.
- Inflation Numbers Thailand and Indonesia.
- US ISM Manufacturing numbers – if it stays roughly where it is (just above 50) that’ll be fine thank you very much. Would not want to see this dip below 50 or shoot above 60.
Markets
Whoops, S&P slipped on a banana skin at the end of the day. That was not really supposed to happen was it? Anyway, it’s a new year, “The January Effect” will be in full swing as new asset managers with new money and new mandates look to plug their investors’ money into something promising.
Expect a little volatility going into earnings season, but I was wrong last season – we saw very little volatility for Q3 reporting.
Global Stocks to Watch:
- The Banks:
- The Aussie Bank, NAB, may make a play for UK nationalized bank Northern Rock?
- Re-introduction of Glass-Steagall?! This would force investment banks to all be broken up.
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