By Gordon L. Johnson of Axiom Capital Research
China’s 1H16 Efforts to Limit Runaway Growth in Home Prices Reflect Failed Tightening Policies (Not Stimulus). A likely acceleration of these efforts in 2H16 (due to record home prices in Aug.), coupled w/ a probable slowdown in bank asset growth (discussed below), we believe, will undermine the key pillars supporting China’s economic “rebound” in 2H16 & rekindle volatility in risky asset classes. That is, while Aug. data was better than expected, perhaps most noteworthy were China’s property prices, which rose for new residential homes m/m, on avg., in 64/70 cities in Aug., the most ever when taking the avg. of all 70 cities. Of course, w/ China’s credit growth up strongly in Aug., we find evidence that some in gov’t continue to support cheap credit to mfr. growth (i.e., total social financing [“TSF”] was +35.4% y/y, local gov’t debt issues YTD total CNY 4.8tn, vs. CNY 3.8tn in ’15, & the PBOC’s medium-term lending facilities [“MLFs”] YTD total CNY 3.0tn, vs. just CNY 0.4tn in ’15).
China’s Resi Real Estate Construction Activity, Rolling 6Month Moving Average, %Y/Y
Not So Fast. While stabilizing to China’s economic malaise in 1H16, when considering: (1) growth in loans to households (dominated by mortgages) increased CNY 3.6tn in YTD ’16 (thru Aug.), vs. CNY 1.9tn in the same YTD ’15 period, or +90.4% y/y, while loans to corporates increased CNY 4.6tn YTD, vs. CNY 5.4tn in YTD ’15, +10.4% y/y, & (2) we find scant evidence of any material increase in China’s tertiary econ. indicators (beyond real estate), we blv this yr.’s record credit growth was largely funneled into the country’s property sector, vs. broad infrastructure spending (suggesting the property mrkt., not gov’t stimulus, contributed to GDP growth in 1H16).
Tertiary Data? With signs of cooling real estate activity showing up since Apr. in land purchases, new starts, space under construction & space sold (Ex. 1), noting the laws of diminishing marginal returns, we are already seeing signs that this cheap credit has run its course; and as buying restrictions are ramped to fight ballooning home prices (e.g., mortgage controls, higher down payments, & residency requirements), we see this slowdown deepening in 2H16.
China’s Secondary Economic Indicators versus Headline GDP, %Y/Y
Bank Asset Growth at Risk? China’s bank assets have grown CNY 18.4tn YTD (thru Jul.), outpacing deposits by a factor of 1.7x, 37.1% of which was from claims on non-bank financial institutions (i.e., receivables for wealth mgmt. products [“WMPs”]). Given the risks these WMPs pose (think CDOs in the US during ‘08) & the gov’t’s crackdown on their proliferation (a form of tightening), we expect bank asset growth to slow sharply, thus compounding a 2H16 slowdown and rekindling volatility across risky asset classes.
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Elaborating On These Points
China’s Failed Efforts to Limit Runaway Growth in Home Prices Buoyed by Cheap Credit Reflect Policies of Monetary Tightening – These Efforts, Coupled w/ A Likely Slowdown in Bank Asset Growth, We Believe, Will Undermine Key Pillars Supporting China’s Economic “Rebound” in 2H16 & Rekindle Volatility in Risky Asset Classes. Economic data points out of China were better than expected in August with growth in industrial production, retail sales, and fixed asset investment all beating Consensus estimates and largely outpacing growth rates recorded in July, while still-muted inflation makes a case for further easing.
Perhaps most noteworthy were China’s property prices, which increased for new residential homes m/m, on average, in 64 of 70 cities in August, the most ever when taking the arithmetic average of all 70 cities (Exhibit 2-3). Of course, given: (a) China’s broadest measure of credit, or total social financing (“TSF”), was up strongly from July, at CNY 1.5tn (versus Consensus’ CNY 0.9tn), a more than 3-fold increase m/m and +35.4% y/y, while (b) local government debt issuances (not included in TSF) increased by CNY 0.8tn, bringing the YTD total to CNY 4.8tn, versus CNY 3.8tn and CNY 0.4tn issued in all of 2015 and 2014, respectively, and (3) the PBOC’s medium-term lending facilities (“MLF’s”) edged up to CNY 3.0tn, versus CNY 0.4tn in all of 2015, we find evidence that some of those in power in China continue to prefer the use of cheap credit to manufacture growth (Exhibit 7-9).
Yet, when considering: (1) growth in loans to households (dominated by mortgages) increased by CNY 3.6tn in YTD 2016 (thru August), versus CNY 1.9tn in the same YTD 2015 period, or +90.4% y/y, versus loans to corporates, which increased CNY 4.6tn, versus CNY 5.4tn in YTD 2015, +10.4% y/y (Exhibit 10-12), and (2) we find scant evidence of any material increase in China’s tertiary economic indicators, beyond real estate (i.e., cement output, rail traffic, apparent oil demand and apparent steel demand are all trending lower – Exhibit 4-6), we believe this year’s record credit growth was largely funneled into the country’s property sector. Contrasting the widely-accepted Consensus view at present, we believe these data suggest the property market, not government stimulus, contributed to GDP growth in 1H16.
However, with signs of cooling real estate activity showing up since April in land purchases, new starts, space under construction and space sold (Exhibit 1), consistent with the laws of diminishing marginal returns, we are already seeing signs that easy credit availability has run its course; and as buying restrictions become more commonplace (e.g., mortgage controls, higher down payments, and residency requirements), we see this slowdown deepening in 2H16.
What’s more, China’s bank assets have grown by CNY 18.4tn YTD (thru July), outpacing growth in deposits by a factor of 1.7x (Exhibit 13-14), 37.1% of which was from claims on non-bank financial institutions (i.e., loan receivables for wealth management products [“WMPs”]). Given the risks these WMPs pose to China’s banking system (think CDOs during the US subprime crisis in 2008) and the government’s crackdown on their proliferation (i.e., also a form of tightening), we expect bank asset growth to slow sharply, thus compounding China’s resumed slowdown and rekindling volatility across risky asset classes.
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