Takeaway: We believe prospects are rising for another leg down in consensus expectations for Chinese growth.

Per the fine folks at Wikipedia: “The defense readiness condition (DEFCON) is an alert state used by the United States Armed Forces. The DEFCON system was developed by the Joint Chiefs of Staff and unified and specified combatant commands. It prescribes five graduated levels of readiness (or states of alert) for the U.S. military, [with an] increase in severity from DEFCON 5 (least severe) to DEFCON 1 (most severe) to match varying military situations.”


China’s Property Market Is In Dire Straits

Prior to today, we estimated the state of the Chinese property market to fall somewhere between DEFCON 4 and DEFCON 5; this is not to say that trends didn’t warrant further attention, but it appeared policymakers were content to let a bit more air out of the [widely perceived] property bubble at the current juncture.


With the latest batch of easing measures out of Beijing, however, we think Chinese policymakers are now officially worried about the state of the country’s real estate sector and have elevated it to somewhere between DEFCON 2 and DEFCON 3 in their own minds.


To recap those measures:


  • Buyers of a second home will be able to enjoy the same 30% down payment as first-time home buyers if they have fully repaid their previous mortgage.
  • This compares to the previous rules which required second homes to have a 60% down payment.
  • Second-home buyers can now get a 30% discount on their mortgage rates as well, a privilege previously limited only to first-home buyers.


The announcement of these measures marks the first official nationwide loosening of property policies since 2008 – a time when both Chinese and global growth were falling off a cliff – and signals real concern on behalf of Chinese policymakers that we don’t believe is currently factored into many investors’ handicapping of key global macro risks.


Beyond these headlines, the trend of localized easing measures continued in recent days with both Nanjing, the capital of Jiangsu, and Shijiazhuang scrapping their housing curbs while also pledging to increase the supply of small and medium-sized apartments and/or low-income housing units. As a result of this multi-quarter trend of policy loosening at the municipal and provincial government levels, only six cities remain with home purchase restrictions in place, including the big four first-tier cities of Beijing, Shanghai, Guangzhou, and Shenzhen.


The key takeaway here is that Chinese officials have now embarked on something just shy of “whatever it takes” in order to  stem the tide of deterioration in the country’s real estate sector. This is a tacit admission out of Beijing that existing measures were not sufficient and that larger stimulus is required to prevent incremental deceleration.


  • Growth in credit available for real estate development slowed sequentially in AUG and is negatively diverging from its trailing 3M, trailing 6M and trailing 12M trends, respectively. Lasting weakness in bank loan growth is weighing on the headline figure.
  • Both the value and volume (square footage) of building sales (i.e. demand) slowed sequentially in AUG and is negatively diverging from their respective trailing 3M, trailing 6M and trailing 12M trends across every category and on nearly every duration. While we tend to overly focus on 2nd derivative deltas in our analysis, the fact that demand for property in China is down 8-9% YoY is a callout in and of itself!
  • Looking to official National Bureau of Statistics figures, house price inflation slowed sequentially in AUG and is negatively diverging from its trailing 3M, trailing 6M and trailing 12M trends, respectively; similar trends are in place across all three tiers of cities. Looking to data from the China Real Estate Index System, average home prices (100 cities) contracted sequentially for the fifth consecutive month in SEP (-0.9% vs. -0.6% in AUG). On a YoY basis, CREIS data showed prices up +1.1% in SEP as 79 cities registered MoM declines; this compares to a +3.2% YoY pace in AUG, when 74 cities registered MoM declines.
  • Confidence and conditions in the real estate sector – which accounts for ~15% of Chinese GDP directly and materially affects some 40 industries – ticked down in AUG and is negatively diverging from its trailing 3M, trailing 6M and trailing 12M trends, respectively.




China Is Likely To Remain An Overhang On Global Financial Markets

Recall the conclusion our September 12th note titled, “THE “BEIJING PUT”: IS BAD NEWS IS STILL GOOD NEWS IN CHINA?”:


“Obviously really bad data would not be supportive of “investor” sentiment – which we’d argue is the primary directional driver of the Chinese stock market – but we doubt policymakers would allow growth data to slip much further from here, given that the property sector is the primary culprit for China’s current growth slowdown.


Specifically, the autocorrelated nature of property markets means that once a trend develops, actors and investors respond in kind by perpetuating the trend. This would effectively reduce Chinese policymakers’ ability to counter a deeper slowdown in property investment with more stimulus.


Net-net, while we don’t see a tremendous amount of upside to Chinese growth from here, we think there is a floor at/near the current level of economic activity and any threat of breaching that level should continue to be met with expectations of incremental stimulus from the marketplace.”


The logical progression of questions in response those assertions is two-fold:


  1. Is Chinese economic growth threatening to breach the aforementioned floor?; and
  2. Will Chinese policymakers actually implement the [meaningful] degree of stimulus investors have been clamoring for throughout this +17.9% move in the Shanghai Composite Index off its mid-June lows?


With respect to question #1, the answer is a comfortable “yes”:


  • Our GIP model has the Chinese economy mired in Quad #4 throughout 2H14. Supporting this forecast is a combination of negative high-frequency data, including but not limited to:
  • Our favorite economic indicator to watch – i.e. the rolling 2M average of the amalgamated YoY % change in monthly average prices of iron ore, rebar and coal – continues to crash (-24.3% YoY) and is negatively diverging from its trailing 3M, trailing 6M and trailing 12M trends, respectively.
  • Official Manufacturing PMI data slowing sequentially in AUG and is negatively diverging from its trailing 3M, trailing 6M and trailing 12M trends, respectively. This trend is true across the majority of sub-indices and for the SEP HSBC Manufacturing PMI figure as well.
  • The National Bureau of Statistics’ LEI, CEI, business cycle indicator and consumer confidence index all slowed sequentially in AUG and each is negatively diverging from its respective trailing 3M, trailing 6M and trailing 12M trends, with the exception of consumer confidence, which is up a measly +1% versus its TTM average.
  • More traditional high-frequency economic data like growth in fixed assets investment, industrial production, retail sales, exports and imports all slowed sequentially in AUG and each is negatively diverging from its respective trailing 3M, trailing 6M and trailing 12M trends.
  • Growth in capital flows has fallen off of a cliff (down -34% YoY) and is weighing heavily upon the marginal rate of change in credit expansion. Both indicators are negatively diverging from their respective trailing 3M, trailing 6M and trailing 12M trends.
  • Inflation has also nose-dived, with headline CPI, food CPI, non-food CPI, PPI and input prices all decelerating in AUG and each is negatively diverging from its respective trailing 3M, trailing 6M and trailing 12M trends.






With respect to question #2, we are increasingly of the view that the answer is “no”:


  • Both monetary and fiscal policy remain supportive of the “fine-tuning” message consistently echoed by Chinese government officials:
  • The sovereign budget balance has swing into deficit territory on a trailing 3M and trailing 6M basis, and the AUG deficit of -109.5B CNY is 88% wider than the trailing 3M average of -58.3B CNY.
  • Moreover, the net 44B CNY injected into Chinese money markets by the PBoC over the previous month is 50B CNY greater than the net -6B CNY withdrawal in the prior monthly period.
  • Earlier this month, Premier Li remarked that the Chinese economy is highly resilient, with plenty of potential and ample room to grow. He went on to say that China will continue leading a prudent monetary policy with focus on targeted easing measures. In line with this guidance for continued “tinkering”, the State Council announced that authorities will allow accelerated depreciation of new fixed asset investments.
  • Last week, Finance Minister Lou Jiwei said the Chinese economy had stayed within a reasonable range and employment was sound YTD. He went on to say that China will not dramatically alter its economic policy because of any one economic indicator.
  • Today, Minister of Commerce Gao Hucheng said the foundation is solid and that conditions are favorable for China to sustain medium or high economic expansion.
  • A senior PBoC official noted last week that in order to hit the government's goal of doubling GDP by 2020 the economy would only have to grow at an average annual rate of +6.7%. Consensus exceptions for Chinese real GDP growth in 2014E and 2015E is +60bps higher than that and +30bps higher than that, respectively. Expect those to get revised down if and when Beijing decides to scrap its +7.5% growth target for a more manageable figure at the end of this year.


Ultimately, the confluence of those responses – assuming our assumptions are indeed correct – should begin to perpetuate incremental fears of another leg down in Chinese economic growth over the intermediate term.


While that might not be bearish for the A-Shares market, it’s likely to continue to weigh on asset prices across the emerging markets space and across various commodity markets – which is a research conclusion supported by our quantitative analysis as well:


  • The iShares China Large-Cap ETF (FXI) has dropped -10% in a more-or-less straight line since peaking on September 5th; the Shanghai Composite Index has actually gained +1.6% over that same time frame. This performance divergence is not inconsistent with the divergences we seen in late-2012 and mid-2014 when the consensus macro narrative adopted by international investors decoupled from the more-informed macro narrative adopted on the mainland.
  • Our Tactical Asset Class Rotation Model (TACRM) continues to generate “high-conviction SELL” signals for both EM Equities and Commodities as primary asset classes.




All told, rising prospects for another step down in Chinese growth expectations is yet another bearish factor in a growing list of bearish factors for you to consider this evening.


Sleep tight; don’t let the bedbugs bite!




Darius Dale

Associate: Macro Team

Cartoon of the Day: Tweedledee & Tweedledum

Takeaway: Peter Thiel says there's no tech bubble. We disagree.

Cartoon of the Day: Tweedledee & Tweedledum - bubble cartoon 09.30.2014

ONE-MINUTE VIDEO | McCullough: ‘Quad 4’ Matters A Lot More to Your Portfolio than a 50-Day Moving Monkey

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Poll of the Day | Tech Bubble: Who's Right Peter Thiel or Keith McCullough?

Entrepreneur Peter Thiel made headlines yesterday telling Fox Business anchor Deidre Bolton that we are not in a tech bubble. Thiel said, “I’m investing in tech stocks to hide from the government bond bubble.” Hedgeye CEO Keith McCullough replied in a tweet to @peterthiel, “I’m hiding in the Long Bond so that I can be short the Tech Bubble.” So, who's right?


Takeaway: Case-Shiller HPI deceleration consistent with Corelogic. The next print from Corelogic will be an important waypoint for housing equities.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume. 




Today's Focus: July S&P/Case-Shiller Home Price Report


Key Takeaways

Home price growth as measured by the Case-Shiller 20-city composite decelerated -140bps sequentially to +6.7% YoY.  The slowdown in July represents the 8th consecutive month of deceleration and the 2nd consecutive month of flat or declining growth across all cities. 


As a reminder, the Case-Shiller HPI series is constructed as a 3-month moving average so the July release reflects HPI changes over the May-to-July period, effectively amounting to June data.  With July data from Corelogic in hand for almost a month already, we knew the slope and likely magnitude of the deceleration for Case-Shiller in July. We should get the Corelogic home price report for August (along with their best econometric guess for September) in the next day or two, which will be the far more important report.   


As we highlighted last month (Corelogic HPI - THE DILEMMA), the abrupt, positive inflection in the 2nd derivative HPI as reported by Corelogic was notable because, historically, equity prices across the housing complex have followed the slope in home price growth very tightly. 


Given the embedded lag in the Case-Shiller data, we’ll have to wait for next month’s release for corroborating evidence of the fledgling inflection in the Corelogic series.   










CASE-SHILLER FOLLOWS THE SLOPE OF CORELOGIC - CS Index weight vs Price growth Scatter 


Bottom Line:

Housing-related equities follow the path of HPI. So long as HPI is decelerating, housing equities will move sideways to lower. We can forecast HPI's path by looking at demand trends on a 12-18 month lead/lag basis. Our expectation is that prices continue to decelerate throughout 2H14 and potentially into 1H15.



About Case Shiller:

The S&P/Case-Shiller Home Price Index measures the changes in value of residential real estate by tracking single-family home re-sales in 20 metropolitan areas across the US. The index uses purchase price information obtained from county assessor and recorder offices. The Case-Shiller indexes are value-weighted, meaning price trends for more expensive homes have greater influence on estimated price changes than other homes. It is vital to note that the index’s printed number is a 3-month rolling average released on a two month delay.


Frequency and Release Date:

The S&P/Case-Shiller HPI is released on the last Tuesday of every month. The index is on a two month lag and therefore does not reflect the most recent month’s home prices.



Joshua Steiner, CFA


Christian B. Drake

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