A "China is slowing" scare?

It's been a while since we've had a "China is slowing" scare, but we may be due for one. The chart of the Shanghai Composite shows that the index violated a key support level last night, which is an indicator of heightened stress.

The chart of the Hang Seng Index also shows that it violated a key support level in September and attempted a failed rally above the support-turned-resistance line. The index is now testing the bottom of a triangle formation, while investors wait for either an upside or downside breakout as an indicator of near-term direction.

China's deflating property bubble
Much of the stress comes from the faltering property market in China. The Los Angeles Times reports that China's housing bubble is losing air:

Home prices nationwide declined in November for the third straight month, according to an index of values in 100 major cities compiled by the China Index Academy, an independent real estate firm. Average prices in the Shanghai area are down about 40% from their peak in mid-2009, to about $176,000 for a 1,000-square-foot home.

Sales have plummeted. In Beijing, nearly two years' worth of inventory is clogging the market, and more than 1,000 real estate agencies have closed this year. Developers who once pre-sold housing projects within hours are growing desperate. A real estate company in the eastern city of Wenzhou is offering to throw in a new BMW with a home purchase.

Patrick Chovanec, professor at Tsinghua University's School of Economics and Management in Beijing, echoed the accounts about deflating housing bubble:

According to the China Real Estate Index, published by Soufun.com, the average primary market housing price across China’s top 100 cities dropped for the third month in a row in November, by 0.3% month-on-month, with prices in 43 cities still rising and 57 cities falling. However, other real estate agencies reported steeper drops in specific locations. Homelink said that in November alone, primary market prices in Beijing dropped 35% month-on-month, and industry sources told the Legal Evening Post they dropped 16.8% week-on-week in the last week of November, down 29% year-on-year. According to Caijing magazine, Beijing home sales volume (by area) in the first 11 months of 2011 was down 27% year-on-year, to a 10-year record low. A similar fall-off was evident in commercial as well as residential real estate. According to the Beijing Morning Post, sales volume for retail and office space in the capital dropped 18% and 7.4% respectively in October, month-on-month. Homelink’s chief Beijing analyst, Zhang Yue, told the paper he saw a growing supply glut developing.

The downturn was not limited to Beijing. Dooioo, another agency, said that primary housing sales volumes in Shanghai are the worst since 2006, while Chinese Business News reported that in Shenzhen, primary prices were down 10.7% and transactions down 11.3% week-on-week in the last week of November. Business China also reported a drastic drop in sales, despite generous discounting.

Chovanec writes that how the market behaves from now on will be a test of Chinese investor confidence in the property market, largely because property purchases are often fully paid for in cash with no leverage and represent a source of savings for individuals [emphasis added]:

How investors in the secondary market will react to the collapse in primary market prices is the biggest question of all. As I’ve mentioned many times, many people in China buy multiple units of housing in order to hold them empty indefinitely, as a form of savings. They do this because they have few attractive alternatives and because they have faith that housing prices will go up. Since many have paid cash, they aren’t under the same immediate pressure to sell as developers. But they do tend to look to rising primary market prices for assurance that their investments are profitable and safe, and now those prices are now plummeting. A great deal depends on whether they hunker down to weather the storm, or join the fire sale.

He does caution, however, that even though many apartments are paid for in cash, there may be other forms of leverage in property purchases. Depending on how pervasive the level of financial leverage, sales could create a cascade of falling Chinese property prices.

Beijing-based blogger Bill Bishop recently related the story of an email he received, which makes equally interesting reading. It came from a real estate agent representing a condo owner in one of the city’s top apartment buildings, in the Central Business District (CBD). Although he had no mortgage, and owned the unit outright, he was desperate to sell in order to raise RMB 20 million for his business. So it’s worth keeping in mind that, while many Chinese investors may not be directly leveraged on their real estate investments, given the credit explosion that has driven the Chinese economy these past few years, they may be highly leveraged in their business or other ways that could turn them into distressed sellers.

Watch for "China is slowing" stories
As the world has focused primarily on Europe and secondarily on the United States, my sense is that the consensus is that China will escape a hard landing. While I am of the belief that China should survive the next economic downturn in relatively good shape, stories like these will serve to heighten investors' sense of emerging market risk. In addition, we are seeing stories about India slowing as well.
Should European or American economies get into serious trouble in the months to come, there may not be any place to hide.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

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