It is normal for buyers in the Chinese real estate sector to pay up front for a property not yet built, and the process has worked well in the past. But the recent drastic measures of the Government in the investment in Chinese real estate stocks They have paralyzed construction throughout the country. This has pushed homebuyers to boycott mortgage payments until they see movement again. And that could end up causing a headache for all Chinese stock investing…
Why are these boycotts so risky?
They will harm the great engine of the Chinese economy️
Investment in Chinese real estate stocks (from property construction to real estate services) is estimated to account for more than a quarter of China's economic output. And according Pantheon Macroeconomics, between 30 and 40% of bank loans are exposed to the real estate sector. Also the sale of land, which represents between 30 and 40% of local government income. So anything that directly disrupts investment in Chinese real estate stocks will have a serious impact on the country's economy as a whole.
Investment in Chinese real estate stocks has been declining for more than a year. Source: China National Bureau of Statistics.
They will harm another great engine of the Chinese economy️
Investment in banking sector stocks is the next big loser in this saga. Its estimated 1,7 trillion yuan (about $250.000 billion) worth of mortgages on its books could be affected by boycotts. Zooming in a little closer, China Construction Bank Corp.'s (one of the world's largest banks) mortgages account for more than 20% of its total assets. Concerns about deteriorating loans have caused the Hang Seng Mainland Index to Banks is down 8% in the last week, with the possibility of the drop being even greater if the boycotts gain strength.
More than 70% of Chinese household wealth is linked to investment in the real estate sector. This means that a sharp drop in property prices could significantly impact consumer spending. The potential drop in consumer confidence at a time when global growth is slowing and inflation shows no sign of abating could spell big trouble for the Chinese economy.
Will hurt investment in Chinese stocks
Investing in Chinese stocks has looked much more attractive than other major economies over the past two years. This is because the country's economy has grown relatively quickly and has not had to face excessive inflation. As a result, US and EMEA investors have poured more money into Chinese equity ETFs than at any time in the last decade.
Monthly flow in Chinese equity ETFs. Source: Blackrock
But if the boycotts impact the broader economy and investors decide to leave the country's stock market, our investment in Chinese stocks could sink.
Will damage investor confidence
Most of China's junk bonds are issued by real estate developers, and investors have been selling them en masse. This has meant that their average profitability has grown to 26%, which makes it increasingly expensive for real estate companies to refinance and get the money they need to continue operating. These boycotts will only make investors trust them less, which could make profitability and the difficulty of refinancing grow even more.
Profitability of Chinese bonds one year ahead. Source: Trading Economics
It's not just about junk bonds: Investors are selling the bonds of even investment-grade construction companies, making it difficult for them to access capital and intensifying their liquidity problems. This makes investing in stocks in this sector and, by extension, the Chinese economy even more risky.
Should I panic?
Not yet. In fact, there are some reasons to be optimistic:(i) The Chinese government has an incentive to act quickly. Xi Jinping is expected to receive a third term in power, meaning his government will do everything it can to prevent boycotts from causing too much damage. And he has many options to do so. From allowing home buyers to delay paying their mortgages to allowing local governments to buy projects from developers. Whichever solution is chosen, China's top-down command economy allows decisions to be made and implemented quickly.
Investing in real estate stocks has exposed the Chinese economy to this possible collapse. Source: Bloomberg Opinion
(ii) Chinese consumers seem to be doing well. Although Chinese household debt as a percentage of the country's economy reached 62% in 2021, it is still much lower than the 78% and 86% of the United States and the United Kingdom, respectively. So while these boycotts are likely to impact spending, investing in Chinese real estate stocks is in a relatively strong position that should serve the economy.
China's public debt has been growing progressively year after year. Source: Bloomberg
(iii) It is unlikely that this will be a situation similar to that of the 2008 Crash. If the crisis worsens, it is likely to be limited to the country itself. After all, Chinese banks' loans to local real estate developers are not as marketable or securitized as those of American banks in 2008. Furthermore, strict government supervision has made foreign investor participation in the investment in Chinese real estate stocks is reduced.
How can we protect our investment in stocks?️
It is not certain that these boycotts will end up affecting Chinese economic growth significantly, but it is also not certain that they will not. So it is best to stay away from investing in stocks more exposed to the Chinese economy. Luxury companies and automakers generate a significant portion of their revenue in the country. We could also be more selective about our exposure to raw materials. Commodities are often seen as a good hedge against inflation, but a slowdown in China's construction sector could dull the shine of commodities such as steel and iron and copper ores. That said, precious metals like gold and silver should hold up.
Commodity-exporting countries such as Australia, Brazil, Argentina and South Africa will likely see weakness in their currencies if China's economic growth begins to slow. Asian economies such as Japan, South Korea, Taiwan, Singapore and Vietnam are also dependent on the Chinese economy, and their stock markets are likely to underperform those of the United States and Western Europe.