When it comes to the Chinese equity market, take your pick of bad news. Falling oil prices, rising interest rates in the U.S., an endless trade war, a massive jump in margin lending by Chinese investors, and a decimated yuan are just a taste of the grim tidings which have led to a 30% decline in Chinese stock exchanges in 2018 alone.
How much worse things could get for Chinese markets is one of the biggest unknowns creating strain in global markets. But there is reason to believe that the worst is yet to come. And the trigger for this massive selloff may spring sooner than anyone expects.
Falling Oil Prices & Margin Lending Most Recent Short-Term Problems Plaguing Chinese Equities
Heavy selling last Thursday took China’s Shanghai Composite index to lows not seen since late 2014. The 2.9% drop, which took the index to 2,486.42, was led by China’s energy sector, although retail and real estate sectors were equally battered by the sharp selloff.
Blame for the 2.9% decline fell on the shoulders of energy prices and margin lending by Chinese companies, who are using their stock shares as leverage to attain new loans.
This increased borrowing has only exacerbated China’s debt fears. According to Reuters, some 4.44 trillion yuan has been pledged for loans as of Oct 12th 2018, or just shy of $640 billion USD. Add to this the growing fears of rate increases by the U.S. Federal Reserve, and that’s reason enough for most stockholders to de-risk and seek investments elsewhere, even if it means defying Chinese capital controls and taking their money abroad.
Are Chinese Equity Markets Reacting to More Than Just Short-Term Problems?
There’s growing concern that the problems plaguing China are too big for Communist Party officials to manage. And perhaps the largest of its long-term fears arises from one of its most thriving sectors: real estate.
Real estate is the driving force behind China’s economic boom. According to data gathered by our in-house analysts, this sector amounts to nearly a third of China’s entire GDP. The endless demand for raw materials and manpower has been an engine of wealth since the early 2000’s. And riding on the back of this real estate boom is China’s nascent middle class, which has seen its personal wealth explode with the valuations of home prices across the country.
But there are signs that the real estate sector—once the country’s greatest boon—could turn into its biggest nightmare if the status quo is maintained. And here, too, you can take your pick of bad news. Rumors of massive ghost cities with properties too expensive to be purchased by middleclass Chinese citizens. Significant indebtedness by some of China’s premier developers to state-run banks. Skyrocketing rental prices that show no sign of being curbed even with government subsidies.
And let’s not forget the words of China’s richest man and real-estate kingpin, Wang Jianlin, who declared China’s property market “the biggest bubble in history.” Take that, Bitcoin!
The consequences of the Communist Party’s policy toward its real estate sector is becoming clearer by the day. SouFun Holdings Ltd., which publishes its 100 City Price Index annually, noted that China’s largest cities have seen their price per square foot for residential property increase by 31%, to $202 per square foot. Again, according to our analysts, that’s 38% higher than the median price per square foot in the U.S., where per-capita income is more than 700% higher than in China.
That Which Booms, Must Bust
Because of its value to the Chinese economy, Communist Party officials have done everything possible to subsidize developers and limit regulation wherever possible to keep the boom from going bust. Even in 2018, government development loans increased by 21%, and investments in residential real estate is up 14%.
China’s Communist Party almost certainly understands it’s sitting on a ticking time bomb of bad debt. But a far off real-estate meltdown was seen as a small price to pay for double digit GDP growth in the near-term.
Unfortunately for today’s Communist Party officials, that meltdown may be coming sooner than they think. And China’s equity markets may be pricing in the beginnings of a sustained bear market that could take stocks lower than anyone ever imagined.