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Avid China-Watchers have seen countless warnings of a property bubble on the brink of bursting in China.  Videos of Chinese “Ghost Cities” began to pop up on the Internet as far back as 2011; showing empty buildings and empty streets.  A Wall Street Journal Study of housing in Chinese cities released in June 2014 added hard evidence to the visual imagery.  According to the study for the 2013 year, 22.4% of the housing stock in urban areas was vacant. What’s more, the vacancies are increasing, rising from a 20.6% vacancy rate in 2011.

On 21 October China released economic data including more troubling signs for the property sector.  While GDP for Q3 came in slightly above economist expectations at 7.3%, GDP for the same period in 2013 was 7.5%.  Investment in real estate fell from 13.2% growth a year ago to 12.5%.  New construction dropped 9.3% and property sales fell 8.9%.  Commercial construction was not spared the pain, with sales growth for the first seven months of 2014 falling 8.4% behind last year’s pace.  Experts point to the near 10% declines in construction and revenue as the culprit behind the 7.3% GDP, the lowest China has seen in almost six years.  Chinese home prices declined again in October, down an average 2.5% from a year ago, the biggest drop since 2011.

So once again talk of the impact of a slowing Chinese property sector on the global economic outlook has moved to the front burner.  And well it should.

First, the real estate sector in China drives about 40 other industrial sectors, from steel to cement to appliances to furniture.  Those “Ghost Cities” required massive infrastructure development and a host of finishing products.  The following graph from the MAPI (Manufacturers Alliance for Productivity and Innovation) illustrates how important the real estate/construction sector is to the overall Chinese economy.  The graph was constructed using data from China’s National Bureau of Statistics to show Direct Demand from Real Estate and Construction as a Share of Total Output:

Second, while the US faltered following the GFC, China stepped in to become the largest contributor to global economic growth. The following graph tells the tale, with the gray areas representing IMF (International Monetary Fund) forecasts.

As you can see from the graph, in 2013 China accounted for close to 30% of GDP growth around the world.  It comes as no surprise then that the torrid pace in economic growth in China has led to an explosion in that country’s share of global GDP.  Since 1995 China’s share of world GDP has gone from 2% to 15%.  The following graph shows market share in both US dollars and PPP (Purchasing Power Parity), which adjusts for differences in currency exchange rates.

The debate over the bubble status of the Chinese property sector is far from over, with some claiming the bubble has already burst. No one denies there has been a slowdown and we have only to look at our own economy to glimpse the potential impact of a complete breakdown in China.

Experts tell us 24% of the steel used in China goes into the residential property market.  The world’s biggest suppliers of iron ore have ramped up production in the face of dwindling demand, contributing in the eyes of many to a collapse in the price of iron ore.  The extreme volatility in price levels over the past years appears to have been replaced with movement in one direction – down.  Here is a graph from Bloomberg depicting the dramatic fall.

The price of iron ore now stands at a five year low and we are reading bearish forecasts of prices below $US60 per tonne due to declines in the Chinese property market.

Once the pride and joy of Australian investors, our mining companies have been hit hard.  The following table shows the share price declines in the top iron ore miners on the ASX.

Company

(CODE)

Market Cap

Share Price

1 Year % Change

BHP Billiton

(BHP)

$170b

$32.05

-16%

Rio Tinto

(RIO)

$105b

$56.90

-14%

Fortescue Metals

(FMG)

$8.4b

$2.72

-54%

Arrium

(ARI)

$755m

$0.24

-83%

Mt Gibson Iron

(MGX)

$430m

$0.395

-64%

Atlas Iron

(AGO)

$194m

$0.215

-82%

Iron Ore Holdings

(IOH)

$112m

$0.70

-23%

BC Iron

(BCI)

$70m

$0.57

-90%

 

While stocks from other sectors are less likely to experience this kind of carnage, there is no denying the much ballyhooed “hard landing” for the Chinese economy would have dire consequence for companies around the world.  Already the largest exporter of goods on the planet, in January of 2014 China passed the US as the world’s largest importer of goods.  

Investors who have kept abreast of global economic developments should be well aware of what seems to be a never-ending debate over the future of the Chinese economic engine.  We have heard this song before and China has managed to continue to grow, albeit at a slower pace.  In a business climate marred by high volatility in most measures, Chinese quarterly GDP has shown ups and downs over the past two years.  The following table shows Chinese Quarterly GDP Growth going back to Q4 of 2011.

Certainly the figure of 1.4% for the First Quarter of 2012 and 1.5% for the First Quarter of 2014 raised some concerns, but the plunge into the abyss failed to materialize.  

The latest indicators from China released on 19 November were sub-par.  The HSBC PMI (Purchasing Managers Index) fell to the lowest level in six months – 50.0 – while the sub-index for factory output fell to 49.5.  A reading of 50.0 represents the difference between economic expansion and contraction.  Prior PMI readings over the past few years support the volatility as the “new norm” argument some experts have posited.   Here is the graph, going back to 2010.

Note that the PMI dropped into contraction territory twice in the last four years and recovered.  Will this time be any different?  Will China continue to grow at this slower pace or will its GDP fall to the 5% range some economists and analysts are forecasting?

Already some experts see faint signs of recovery in the all-important Chinese property market.  Although housing prices are declining, the October figures saw a four month low in the rate of decline of 0.8% and demand for mortgage loans also improved slightly.  The Chinese government has intervened in the past to support economic growth and they have already taken some steps to support the housing market.

Policymakers have eased regulations to allow more buyers access to lower mortgage rates and lower down payments, as well as increasing liquidity to lenders.  To discourage real estate speculation the Chinese government had required a 60% down payment for second-home buyers.  The new regulations allow a 30% discount on mortgage rates for these buyers as well as lowering the down payment requirement to 30%.

A property analyst at Barclay’s Bank thinks these regulatory changes could lead to an increase in sales by the end of Q4.  Others are skeptical, stating the measures will not lead to a “rapid recovery.”  China-watchers know that the country has surprised before.  

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