This podcast was first and originally published by Peter Lewis’ Money Talk. Find the Substack here: https://peterlewismoneytalk.substack.com/p/peter-lewis-money-talk-wednesday-1af
Topics discussed:
- Country Garden creditors agree to extend onshore bonds
- Apple unveils the iPhone 15 at its latest product launch
- US Stocks Dragged Lower By Tech Shares
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In recent times, the global investment community has been increasingly concerned about the stability of the Chinese and US property markets. The latest Bank of America fund manager survey has revealed a significant shift away from emerging market stocks, particularly in China, towards the US. Survey respondents expressed growing apprehension over the Chinese property sector, which they perceive as the primary threat to the global economy. This sentiment is not limited to foreign investors alone; local investors in China are equally skeptical. Meanwhile, the US market has seen a remarkable outperformance compared to its Chinese counterpart. With the potential for credit events looming in both countries, the repercussions could have far-reaching implications.
Chinese Property Market Woes
China’s property sector has been grappling with a series of challenges this year, resulting in its status as the worst performing market worldwide. The negative sentiment towards Chinese equities comes as no surprise, considering the significant drop in price momentum. The Bank of America survey indicates that a third of fund managers view the Chinese commercial real estate market as the most likely source of a systemic credit event. While recent policies aimed at reviving the property sector have shown some initial positive impact, the market’s response has been short-lived. As cities strive to remove restrictions on home purchases and make housing more affordable, it remains uncertain whether these measures will lead to a sustained recovery.
Disconnect Between Foreign and Local Investors
One might assume that local investors in China would have a more positive outlook on the market compared to their foreign counterparts. However, this is not the case. Both foreign and local investors have struggled to generate profits, making it increasingly difficult to justify investments in the Chinese market. Adding to the complexity are the rising presence of quantitative funds, which employ high-frequency trading strategies and advanced technology to exploit market inefficiencies. With these funds consistently outperforming traditional traders, the sentiment among domestic investors has turned increasingly negative.
US Market Attraction Despite Stretched Valuations
While US fund managers have been selling Chinese equities for some time, the allure of the US market remains strong. The survey reveals that investors are pouring back into US stocks, even though valuations appear stretched. The relative strength of the US dollar, interest rate differentials, and ongoing portfolio reallocation contribute to the attractiveness of the US market. However, the US market is currently undergoing a transition phase, with changing sentiment and interest sector dynamics. Thus, investors should remain cautious even in the face of apparent opportunities.
The Lurking Threat to Global Economy
The Chinese and US property markets pose significant threats to the global economy, with credit events on the horizon. These events, when they occur, will undoubtedly have a painful impact on the global financial landscape. Chinese real estate, along with US commercial real estate, are the two main catalysts that could trigger systemic credit events. Both governments are working diligently to slow down these events, but the inevitability remains. The potential bankruptcy of large property developers or regional banks in both countries could be the trigger that sets off a chain reaction of economic consequences.
As investors worldwide grapple with the uncertainties surrounding the Chinese and US property markets, the specter of credit events looms large. The negative sentiment towards Chinese equities and the outperformance of the US market have driven significant shifts in investment strategies. While the Chinese government has implemented numerous policies to revive the property sector, their impact has been limited. Similarly, the US market, despite its apparent strength, faces challenges due to commercial real estate valuations and potential bank failures. The impending credit events in both countries could have profound implications for global financial stability. As the world watches, it remains to be seen how these events will unfold and whether governments can effectively manage the fallout.
Transcript
Peter Lewis
Tony, from your perspective over there, we know that US fund managers have been sellers of Chinese equities for a while, but there is also obviously a geopolitical element to this as well, isn’t there? In that a lot of fund managers are finding it hard to justify to their clients why they’re even in the Chinese market in the first place. I presume this report is not a big surprise.
Tony Nash
No, it’s not a big surprise. I think the Chinese economic officials had a lot of sentiment in their favor earlier this year. Had they done some of the measures that they’ve taken over the past couple of weeks, I think foreign investors would have been very happy to invest more in China, and they would have justified the political issues, they would have pushed them to the side. But because the central government and local governments have been so slow to bring about these measures, there’s inertia, and that inertia has become negative sentiment. I think now it’s going to be very hard to get foreign investors, at least American investors, really interested in China because it’s gone from a financial opportunity to a political liability. Really, that financial opportunity is at least gone for now.
Peter Lewis
I mean, what stands out this year is the huge outperformance of US equities compared to Chinese equities. I think it’s the biggest gap since about 2002, but according to the survey, it looks like it’s going to get even bigger because investors are jumping back into US stocks despite, I suppose, what a lot of people would say, pretty stretched valuations there.
Tony Nash
Yeah, well, when you look at the strength of the dollar on a relative basis, when you look at interest rates in the US and you look at the incremental nature of tightening in the US compared to the easing we have in some other places, I think the US market becomes relatively more interesting. Now, that’s not to say the US market is easy. The US market is in a transition phase right now where there’s a lot of reallocation of portfolios because the sentiment and the interest price sector is really changing at the moment.
Peter Lewis
Hao, the government has done its mortgage rate cuts, it’s cut the down payments as well. It’s made clear it’s going to try and support the UR. What happens next? What does it do next?
Hao Hong
Well, some of the cities, as I mentioned just now, we’re all purchasing restrictions on property. They can give HUCO, which is a residency permit for many cities to rural households to attract them to move to the city, become a city, urban citizen, et cetera, et cetera. There’s still a few other policies that is up to speed, but I think at this stage, as you can see, there have been plenty of policies coming out, but I think the effect is actually like, Laskia. If you look at the first eight months of sales for this year, it’s even lower than last year. There, in many of the cities. That is concerning despite all the policy support.
Peter Lewis
Is there something you in particular would like to see being done or the Beijing authorities doing to really perk up the market? Because as you said earlier, everything they do, it seems to cause a rally which is very short-lived, isn’t it? It just doesn’t seem to have legs, any rally that we’ve seen in the last few months. Is there anything that you would like to see that would make this rally more sustainable and make Chinese equities more attractive?
Hao Hong
Yeah. Well, it is not about saving the Chinese staffs. The Chinese staffs can respond to the economic cycle itself. I think the Chinese property is the biggest asset class in the world. It’s worth 500 trillion bucks, so it’s just huge. It’s imperative to save it. I think that is the reason why there’s so many policies come out aiming to save, to rescue the sector. But the problem is that the profit price is so high. If you look at the house price to income ratio in China is highest in the world. In many of the big cities like Beijing or Shanghai, the prices in terms of income is even higher than, say, Hong Kong and New York and of the top 10 most expensive cities in the world, I think China takes over five. This is just staggering. I think once price gets to this level, households find it exhausting, unaffordable to buy. Then at the same time, you still have the oversupply situation going on. On one hand, you have the new home is still being built. They’re like six billion square meters of residential buildings and the construction. Then at the same time because the price is so high and also the government is trying to shore up confidence to attract people back to the property market.
Hao Hong
The second-hand listing this year has exploded basically. As the policy come out, there are more and more secondary listings coming to the market. Even to just clear this inventory takes close to two years at the current speed. On one hand, you have a very expensive, restrictively expensive property sector, and then on the other hand, you have the oversupplied situation. I think that’s the reason why the market felt to respond to policy initiatives.
Peter Lewis
Tony, from over there, do you see the Chinese housing market as being the biggest threat to the global economy on the biggest maybe systemic credit events here? Is that what we’re heading to?
Tony Nash
Chinese real estate, US commercial real estate are the two main credit events that are yet to happen, and when they do happen, it’s going to be painful. They’re both going to be painful for everybody. And I think once one happens, the other will happen. There is only so much governments and local officials can do, whether it’s in the US or in China, to keep markets from clearing. So the problem that we have in the US with commercial real estate is we have commercial properties that are marked to a level that’s higher to market. They’re valued at a level that’s higher to market. In China, you have properties that are… Markets can’t clear, so they’re marked to a value that’s higher than market. And so there are a number of other dependencies, the solvency of banks, and other things that are linked to the valuations of those assets. And once that happens, it cascade through the economy and really it’s going to hurt.
Peter Lewis
Is it going to be a black swan event in the sense that people just aren’t really prepared for this? Or is there a growing awareness in the US about the risks from the property sector, both in, I mean, maybe in the US? But I should imagine most people are not particularly aware of what’s going on in the Chinese property sector?
Tony Nash
Well, I think both governments are trying to slow the event down. They know it’s going to happen, but they’re trying to slow it down. Through in the US, with the regional banks, we had the BTFP, which was from the federal government, which is a funding program for regional banks because a lot of the issues with regional banks have to do with commercial real estate. In China, they’re doing similar programs to slow the markets down so that we don’t see things bottom too quickly. Things will bottom, but we need to slow down that deceleration of those prices so that somehow we can make it up. Everyone knows there are going to be credit events, very large credit events, but whether it’s the monetary officials or, say, the other governing officials, they’re just trying to slow this down so that it doesn’t disrupt things too abruptly.
Peter Lewis
I’m wondering what could be the trigger that actually makes it a global credit event? I suppose maybe in China it could be the bankruptcy of a very large Chinese property developer. We know Country Garden is struggling to stay afloat. What about in the US? What could be the trigger for this event?
Tony Nash
It could be bankruptcy of a large commercial real estate. It could be ongoing bankruptcies of regional banks because in the US, a lot of the financing of commercial real estate is from these regional banks. So it could be more of those regional banks blowing up. It could be even highly urbanized cities in the US potentially going bankrupt because they don’t get the taxes from those commercial real estate buildings. There could be a number of things that could happen as a result of commercial real estate in the US. It’s unlikely to be something that we can name. It’ll likely come from something unexpected that will eventually cascade into the broader market.
Peter Lewis
How will you hear this? This is why are you? I mean, we could have a credit event simultaneously in the property sector in both China and the US.
Hao Hong
Yeah, Tony is right. It will be very difficult to pinpoint what could be the catalyst to catapult the Chinese credit system into Telspin. Also, as you can see, Country Garden seems to be able to extend its credit terms and also pay back the creditors on time in recent months, despite 2.4 trillion rand worth of the loan that is on the balance sheet. Sorry, that’s Evergrande. Also, Country Garden has about 1.4 trillion rand loan on the balance sheet as well. Just imagine, these are just two developers, even though they are the largest developers in China and probably in the world. But if you look at there are hundreds, at least 100 very significant, large property developers in the world and they all have a similar financing structure. Just imagine that. Each year, the Chinese property sector sells about 10 to 12 trillion euros of property. I think in 2001, we sold 18 trillion euros of property. It’s like 20% of the Chinese economy. That is just huge. It remains to be seen. I think the Chinese government is trying all they could to reinforce the credit risk. Also we did have a credit event two years ago, which is the high net, the high non-air.
Hao Hong
It has about 2 trillion Yen worth of loan on its balance sheet, and the government was able to restructure that. But I think this time around, because the entire sector is in trouble, I think the magnitude of credit risk that we are talking about has increased exponentially.
Peter Lewis
As well as the property sector, there’s another problem, isn’t there, for the Chinese market? That is the yield gap between yields on US government bonds and Chinese government bonds. I think the 10-year yield gap between the US and China is now at a record high, which in turn is putting downward pressure on the UN. I presume this is also negative for Chinese stocks.
Hao Hong
Yes, because the trade union has been under pressure for some time now. I think the latest, lowest one is about 7.36, which is the lowest in I think in recent years, even including the period of COVID. You haven’t seen again we come to this level. But it really…Firstly, it’s an indication of how large the yield gap is, and then secondly, it’s an indication of how pessimistic the market has been towards China. But I think having said all that, though, if you look at how the Chinese currency cycle runs and also with all the stimulus policy coming out, the Chinese currency’s real effective exchange rate is around a cyclical bottom. I’m saying the level between 7.3 and 7.4 is actually, from a cyclical point of view, is actually a cycle for the yuan. If this is the bottom of the cycle, then it means that policy has to become effective to reinforce the property sector risk and also help the Chinese economy get back to its solid footing. It remains to this thing once again, but I think 7.3 and 7.4 could be the lowest point at this cycle for the real effective to stream trade.
Peter Lewis
Tony, this is obviously what’s going on here with the euro and with these spreads is very much down to the Fed as well, isn’t it? It’s not just a Chinese issue. We’ve got the important consumer price inflation data coming out tonight, which might tell us a bit more.
Tony Nash
Yeah, I think when we look at the Chinese euro, and I think our expectations are that Yana is going to hit about 7.5 in December, January, and I know that sounds extreme, but short of any major policy changes, we could be headed toward a bit more devalued than people are comfortable with right now. But the yield gap, as you mentioned, is so extreme right now. And if the Fed raises any time between now and the end of the year, they’ll drain even more money out of the Chinese economy and out of emerging markets. So it becomes even more difficult. So that CPI print that you’re talking about, I wouldn’t be surprised if it comes in, we’ll say an acceptable level, and the Fed takes a breather this month and just waits until the September data that comes in October. I think there’s so much pressure on the Fed right now to just take it easy so that some things can stabilize that I think the CPI data will come in an acceptable boundary and the Fed will be really pushed to keep it stable this month.
Peter Lewis
But presumably whatever happens, even if there’s a pause, we’ve got to get used to the idea that this is going to be a long pause, that there’s not going to be any cut in rates anytime soon.
Tony Nash
Well, yes, assuming that there isn’t a major global credit event.
Peter Lewis
Right.
Tony Nash
Major global credit events, we’ll see the Fed loosen very quickly. So we’ve already started to see real estate markets in the US slow in the last few months. And that’s okay for now, but if we see major credit events in both China and the US, we could definitely see the Fed do even intermediate rate cuts if it’s extreme.
Peter Lewis
There was this report, wasn’t there, in the Wall Street Journal over the weekend that was suggesting that there is already a consensus now to pause rates next week, but also a growing consensus amongst Fed officials that the priority now is not to keep raising rates, that maybe they’ve done enough. Do you think that’s correct?
Tony Nash
I do think that’s correct. I think we have hit a point in the US where you can definitely feel things slowing in economy, in transactions. People feel very financially stressed right now, probably more so than you’ll see in surveys. I think if the Fed were to continue to raise, it would be a very… They’d be in a very difficult position, not just in markets, but also politically. Going into an election year to have people as financially stressed as they are going into an election year could be an untenable position for the Fed.
Peter Lewis
It makes it seem, Hao, doesn’t it, that there is a symbiotic relationship between China and the US at the moment, what the Fed does is clearly impacting Chinese markets and the economy. At the same time, if we get this credit event or worsening situation in the property market, that could be the issue that causes rates to start being cut.
Hao Hong
Yeah, well, I think the market is quite hawkish towards what the Fed is going to do once the CPI figure come out. I think the market is towards a higher CPI than expected. But for the Fed to move… Well, for the Fed to change its decision criteria just based on one CPI data, and also just because CPI is meeting expectation, it doesn’t mean that the Fed has to change its decision criteria. I’m with Tony here. The Fed is ready to move to rescue if there is a global credit risk event happening. I think for China, because the Fed is still maintaining its posture and also given the weakness in the domestic property market, it actually limits the PPOC’s policy choice towards how to rescue the domestic market. But having said all that, what we’re seeing in the global picture, the mandatory policy is that China has no choice but to east. I think the Fed is towards the end of its hiking cycle. I think the BOJ is probably the biggest uncertainty here in the sense that it has to defend its YCC, its policy intent. But then at the same time, it seems to many people in the market that the BOJ is losing control of the Yen and also losing control on the long end of the JJV.
Hao Hong
I think actually out of all the central banks in the world, the BOJ could be the most volatile affected to watch out for.
Peter Lewis
Okay, well, there’s some interesting comments from Governor Ureda over the weekend about maybe slowly exiting this ultra-loose monetary policy. Let me ask you about the Chinese economy, Hao before we finish, we had data that showed credit expanded more than expected. Also we’ve had the inflation data which shows consumer prices at least are creeping out of deflation. We’ve got more data coming on Friday in terms of retail sales, industrial production, and the like. Do you get any sense from the recent data that maybe the Chinese economy now is turning a corner?
Hao Hong
One data point doesn’t make the point, but I think August data is indeed better than expected. I think because the interest rate is so low now, so there has to be incentive for people to at least refinance or borrow to expand the businesses. We need a few more data points to confirm this. Also in terms of retail sales, if you travel domestically in China, like I did in recent months, you actually noticed that the Chinese economy is not as badly performing as the economic data is telling us. Everywhere I go, hotels are fully booked, train tickets are very difficult to find and the planes are flying at good capacity. It’s just staggering. It’s a very complete different picture from what the retail sales numbers is telling us, which is understandable because the retail sales number doesn’t include a lot of services that the Chinese consumer is enjoying. I think as a result, there’s a split between the reality and also what the data is telling us.
Peter Lewis
Okay, Tony, final comments from you. I want to switch topics a little bit. Talk about the G20 that was concluded in India over the weekend. From a US perspective, how do you see the G20 Summit? Did there anything concrete, anything useful come out of it?
Tony Nash
I mean, I don’t really seen a lot coming out of G20 Summit generally. I do think that it was India’s moment to shine. I think Prime Minister, Modi, did a pretty amazing job holding things together and coming to agreement on their statement on Ukraine and other things, and also inviting the African Union to join the G20. I think these were some really interesting moves that he oversaw and things that he intentionally wanted to get through, especially around Africa.
Peter Lewis
I mean, it was a bit of a diplomatic coup, wasn’t it? Really for India and for India’s diplomacy, then it managed to actually get that agreement at all. So I suppose from India’s perspective, it was a big success.
Tony Nash
Yeah, absolutely. And I think some of the statements that were made around Ukraine and Russia, I think for India to be agreeing with those statements was really a coup for the US and Europe to get India to agree to those statements that were critical of Russia, since Russia is such a long-standing ally of India. So I think we are seeing India, we’re seeing the US particularly, really focus on India as maybe not necessarily the closest of allies, but a closer ally than they’ve traditionally been. And all of this is about power playing in Europe, right? And so, yeah, Modi knows what’s happening on all sides as well as a very depth theater. And so it’s really India’s moment to shine. And I think they’re being very smart about how they’re taking advantage of power politics in Asia and their relationships with the West.
Peter Lewis
I mean, Narendra Modi is the world leader, isn’t he? Playing both sides off against each other and sitting in the middle and getting the benefit of it all.
Tony Nash
Yes, he is absolutely. And India has traditionally played all sides against, not all, but many sides against each other for a long time to optimize their outcome. But Modi is very much a master of that.
Peter Lewis
And what about Vietnam? President Biden went off to see, went off to Vietnam after the summit. Is that becoming a more important relationship for the US?
Tony Nash
Yeah, it is for a number of reasons. Obviously, as, say, American companies relocate some of their manufacturing to other places, they’re looking to Vietnam and Mexico and a few other places. But also from a Chinese perspective, if you look eastward and you see Korea, then Japan, then Taiwan, and Philippines, and now Vietnam as a US ally, it really starts to make a mark after a while that these countries really are allied with the US and they’re not necessarily allied with you. I would expect China to really change some of their diplomatic tones with some of their neighbors to try to build relationships. They’ll, of course, start with Vietnam because they do have a good relationship. But I would expect them to soften. I mean, they’ve really softened from the wolf or ear position of, say, a year ago to where they are now, and I would expect China to soften a bit more for its Asian neighbors.
Peter Lewis
Hao, just very quickly from you on this, I mean, it doesn’t change the fact, does it? That Vietnam is still pretty close to China and very dependent. Its economy is also very dependent upon China.
Hao Hong
Yeah, well, I think the Vietnamese are doing very well. It is like a China back in the ’90s, 30 years ago, the whole country is very focused on economic development. As you can see, recently, many of the US manufacturers is relocating their production facilities to India and also to Vietnam as well. Vietnam is a country of close to 100 million people. It’s a very substantial in terms of labor force. What is a big plus to that country is that they’re really focusing on economic development, while China seems to be preoccupied with other things.
Peter Lewis
Okay, well, thank you both very much for your thoughts this morning. Have a great day. That’s Hao Hong, who is Chief Economist at Grow Investment Group, and Tony Nash, who is the Founder of Complete Intelligence over in the USA.