Charting China's declines

It's been a difficult year for investors in China. The A-shares of the Shanghai stock exchange are down 21.3 per cent:

While 1,200 odd kilometres south-west in Hong Kong, where several large Chinese companies are listed, it's also been tricky, down 15.6 per cent:

So whats going on? China's GDP growth just came in at 6.5 per cent in the third quarter, the slowest pace since the crisis a decade ago, but that's not the whole story.

Anne Stevenson-Yang of JCap Research has a few ideas. In a new note, she cites tightening credit conditions, slowing M2 growth [we'll explain that below], falling real estate prices and a shadow debt pile as particular concerns. From the note:

Since the second half of 2017, China’s government has been on a loudly promoted campaign to reduce credit growth — called, in political parlance, “deleveraging.” M2 growth is at 8.3%, the lowest in more than a decade. New financing to the real economy is down 13% through September. Although the PBoC lowered the [reserve requirement ratio] , banks used half the money freed up to repay their loans from the central bank and, they say, used most of the rest to shore up their balance sheets. Interbank lending is in decline, part of the authorities’ effort to start tackling problems with bank balance sheets.

Indeed, broad money growth, or M2, is in decline.

M2 — which includes liquid assets, such as money market funds, alongside cash and deposits — is normally a pretty good measure of economic activity. Banks, in the good times, are happy to extend credit to borrowers for everyday activities, which will naturally show up as an increase in the M2 statistics in the form of either in bank deposits or other liquid financial instruments.

Check out a chart from Janus Henderson's MoneyMovesMarkets outlining how low Chinese M2 growth this year has been relative to the past six years:

Feel free to offer interpretations in the comments. Also, note the recent flatlining follows the People's Bank of China cutting banks' reserve requirements in both June and earlier this month. It seems creating more room for the banks to lend isn't having quite the desired effect.

Or maybe it is. Strangely, bank loans haven't slowed quite as much as M2, according to Yardeni Research:

This suggests credit is finding its way into less liquid assets -- which are not included in M2 calculations -- such as equities and real estate. This could prove to be problematic if credit conditions suddenly tighten, as unwinding these investments will be trickier given their lack of inherent money-ness.

Speaking of real estate, here's Stevenson-Yang again:

Lower lending growth has immediate ramifications for asset prices, wealth effect, and, therefore, spending. Secondary housing markets in major cities are all but frozen, and transaction growth is in decline. Anecdotally, prices seem to be declining. Both public and private statistical organisations stopped publishing data on home prices finally in 2017 after gradually degrading the statistics. Nationwide on average, prices seem to be steady. But smaller developers are increasingly challenged to find credit.

Alphaville has been reading Dinny McMahon's excellent China's Great Wall of Debt, which outlines in stark terms just how crucial the real estate sector is to the growing wealth of Chinese citizens.

For instance, here's one paragraph from the book (do read if you have the time):

Real estate — which includes shopping malls and office towers as well as apartments, both of which are suffering their own gluts — is the bedrock of the Chinese economy, accounting for about 20 per cent of GDP in 2013, a level similar to that of both Spain and Ireland when they were hit by the Eurozone crisis, and triple the level of the United States before the subprime mortgage crisis.

And, as we all know, a large real estate market requires large amounts of credit — so tightening can only be a negative for prices. Indeed, according to Stevenson-Yang's calculations, Chinese credit and real estate sales have moved pretty much in sync over the past decade:

The recent break between credit impulse and sales counteracts a wider trend in the Chinese economy, which has seen a slowing in fixed asset investment growth over 2018.

From Torsten Slok at Deutsche Bank (more in the usual place):

But despite these continuing flows, real estate prices have not held, with several reports of discounts being handed out to property buyers across major cities. This can't end well, Stevenson-Yang says:

It is worth noting that the broad decline in investment residential property prices is neither an isolated nor short-term event. Like the Shanghai equity market slide in June 2015, or the bitcoin collapse of 2017, retail investors who had experienced only appreciation learned that values can move down. That realisation irreversibly altered the sentiment of retail investors, many of whom never returned to the investment products. The same is afoot with residential property. What is being undone Is the dual belief that property will appreciate forever, some years slower and some years faster, and that the governments at all levels are committed to making it so. Families that have leveraged property investment will find it very difficult to unwind with much left at all. Families with less at risk are likely to return to genuinely safe big bank deposits and settle for considerably lower returns.

In other words, sharpen your claws China bears, the worse may be yet to come.

Related Links:
China’s rising share pledges pose market risk — FT
Evergrande's puzzling debt raise — FT Alphaville
Overheard in the Long Room: corporate China — FT Alphaville
A hint about the future of leverage in China — FT Alphaville
Hong Kong's sudden equity collapse syndrome — FT Alphaville
Evergrande: debt behemoth — FT Alphaville