BUYING CHINA ON WEAKNESS

Takeaway: We’ve used the post-Lunar New Year weakness driven by property curb speculation to increase our allocation to Chinese equities.

SUMMARY BULLETS:

 

  • All told, we’re using the weakness induced by rising speculation of incremental property curbs to increase our allocation to Chinese equities – one of our team’s top global macro investment ideas since DEC 10.
  • Specifically, we have been particularly keen on the outlook for the Chinese consumer and stocks that have exposure to that sector and the outperformance has been noteworthy: +12.7% for the MSCI China Consumer Discretionary Index since DEC 10 vs. +5.1% for the MSCI China Index over that same duration.
  • Based on our analysis of recent supply/demand/price trends in the Chinese property market and recent policy maneuvers, we think it is unlikely Chinese policymakers will pursue any draconian curbs at the current juncture. Moreover, we anticipate any developments in the way of incremental property market  curbs to be eventually overshadowed by the introduction of growth-friendly economic reforms at the 12th National People’s Congress (~MAR ’13).

 

Overnight, Chinese property stocks dropped -4.6% on speculation that the Chinese Communist Party leadership is considering additional property market curbs. That was the largest day/day % decline since early AUG and the speculation was driven by a recent trend of higher imposed LTV ratios and/or loan caps in the Zhejiang, Jiangsu and Guangdong provinces.

 

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Weakness in the developers – which we consider a key leading indicator of Chinese economic activity (Real Estate Development is ~20% of China’s Fixed Capital Formation and Land Sales account for ~40% of local gov’t revenues) – dragged the broader index lower to our immediate-term TRADE line of support.

 

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To some degree, recent weakness in the CNY has been foreshadowing this brief move lower in Chinese equities, though, to some degree, the PBOC has been combating appreciation pressures born out of Japan’s recent Currency War tactics.

 

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The speculation on additional property curbs also came on the heels of weak Lunar New Year Retail Sales growth figures (+14.7% YoY vs. +16.2% in 2012 and the slowest since 2009’s +13.8% YoY advance). The fact that the Finance Ministry is developing incremental curbs to be applied on local gov’t debt also continues to weigh on Chinese growth expectations.

 

A subdued Chinese growth outlook is something we’ve been calling for many months now. Specifically, we continue to see directional improvement in the Chinese economy, but not to absolute levels previously associated with peak growth rates of Chinese demand. This view remains both accurate and supportive of our bearish TAIL-duration bias on commodities.

 

You can see evidence of this real-time in the forex market having priced out expectations for structural yuan appreciation amid China’s drive to rebalance its economy away from investment, manufacturing and exports towards increased household consumption. That will obviously weigh on China’s trade and current account balances going forward.

 

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With respect to this  ongoing theme of Chinese economic rebalancing, the next major catalyst to come down the pike on the policy front is the 12th National People’s Congress, which will likely convene in MAR. There, members of the new seven-man Politburo will assume their formal roles as leaders of the Chinese state and formally outline their strategies to promote domestic demand.

 

We’re hoping for meaningful advancement of social security expenditures and perhaps some degree of early hukou reform(s) that may help advance China up the urbanization curve, but we’d settle for a continued focus on tax incentives (such as expanding the VAT reform to more regions and/or industries or incremental tax cuts for SMEs) and subsidies for now. Rome wasn’t built in a day and the Chinese consumer won’t be either.

 

With respect to the aforementioned property curb speculation, we do expect the CCP to announce additional measures in line with what various officials have been hinting at for weeks. As such, we don’t think any new curbs will be as punitive as the market anticipated this morning. The recent indefinite postponement of the nationwide property tax trial is but one piece of evidence the CCP isn’t looking to get too aggressive just yet.

 

And there’s little reason for them to be aggressive right now. Per our latest monthly data (Hedgeye China 20-City Nominal Price Index), we have Chinese nationwide property prices growing at only +2.3% YoY (from +0.5% in NOV). The MoM gain of +0.5% in DEC actually slowed -10bps from NOV’s +0.6% reading. By our count – which is as good as any we can find – Chinese property prices are down -10.2% from their JAN ’10 all-time peak.

 

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Looking to data from Soufun Holdings Ltd., Chinese property prices rose +1% MoM in JAN – the largest gain in two years according to their index. Inclusive of the aforementioned peak-to-present decline, average square meter prices in the 100 cities tracked by SouFun are roughly five times the average Chinese consumer’s disposable income. Obviously, prices remain somewhat frothy with respect to incomes, but certainly not to the extent they once were or will be amid the CCP’s structural consumer income growth agenda. Hence, we don’t find it prudent for the CCP to authorize draconian curbs (such as meaningfully tightening credit policies for 2nd and 3rd homes or raising/implementing punitive taxes) at the current juncture.

 

As the following chart highlights, overall activity in China’s real estate sector remains incredibly subdued. Sure, it’s improving from an intermediate-term perspective, but we’d have to see a lot more activity here for us to get worried about another round of major, growth threatening curbs. There’s likely a fair amount of equity market upside between now and then – particular when factoring in China’s TREND-duration GIP outlook.

 

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On balance, trends across the supply/demand/price dynamics of China’s property market continue to suggest little in the way of curb-requiring exhaustion:

 

  • YTD Land Areas Purchased: -13% YoY in DEC from -14.8% in NOV
  • YTD Starts: -6.7% YoY in DEC from -7.2% in NOV
  • YTD Construction: +12.9% YoY in DEC from +13.3% in NOV
  • YTD Completions: +11.4% YoY in DEC from +14.1% in NOV
  • YTD Floor Space of Buildings Sold: +1.2% YoY in DEC from +2.4% in NOV
  • YTD Total Sales of Buildings: +9% YoY in DEC from +9.1 in NOV
  • YTD Funds Earmarked for Real Estate Development: +16% YoY in DEC from 14.1% in NOV
  • Outstanding residential mortgage loans grew +12.9% in 2012 – the slowest pace of growth in four years
  • DEC Steel Products Production: +14.5% YoY from 15.9% in NOV
  • DEC Copper Products Production: +8.6% YoY from +0.5% in NOV
  • DEC Cement Production: +3.8% YoY from +6.9% in NOV

 

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All told, we’re using the weakness induced by rising speculation of incremental property curbs to increase our allocation to Chinese equities – one of our team’s top global macro investment ideas since DEC 10.

 

Specifically, we have been particularly keen on the outlook for the Chinese consumer and stocks that have exposure to that sector and the outperformance has been noteworthy: +12.7% for the MSCI China Consumer Discretionary Index since DEC 10 vs. +5.1% for the MSCI China Index over that same duration.

 

Based on our analysis of recent supply/demand/price trends in the Chinese property market and recent policy maneuvers, we think it is unlikely Chinese policymakers will pursue any draconian curbs at the current juncture. Moreover, we anticipate any developments in the way of incremental property market  curbs to be eventually overshadowed by the introduction of growth-friendly economic reforms at the 12th National People’s Congress (~MAR ’13).

 

Darius Dale

Senior Analyst


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