Skip to main content

Sizing up the risks for China Macro


Investor sentiment for Chinese equities and bonds continues to weaken, both offshore and onshore. 

Reports of sporadic and ever more frequent lockdowns across the country, most recently in Chengdu and Shenzhen are rattling confidence and many global investors have chosen to sell amid the ongoing uncertainty. The negative sentiment among investors has been compounded by ongoing investigations by the Chinese government into internet monopolies. Coupled with ADR delisting risk (which is not over until the pcaob has completed their audits and some say they want to start with Alibaba’s papers) along with high profile reports of mortgage boycotts by purchasers of uncompleted housing projects are only compounding the sense of unease about china’s macro growth and corporate profits going forward. 

Despite the nearly 20% plunge in the value of the CSI 300 index so far this year, an index composed of 300 of the largest and most liquid stocks listed onshore in Shenzhen and Shanghai, onshore Chinese investors are more optimistic. Peculiarly many of the more prominently dual Hong Kong and Mainland listed shares of large Chinese companies like BYD or Conch Cement still trade at large premiums onshore versus in Hong Kong (15%~25%). Given the existence of the Stock Connect programs between Shanghai, Shenzhen, and Hong Kong, such premiums shouldn’t exist to such a large extent, although controls on the connect do limit most of China’s 180 million retail investors to sticking onshore as most don’t meet the 500k yuan account balance hurdle to trade through the connect. Nevertheless the dramatically higher valuations of onshore stocks versus their Hong Kong listings should give pause to those who are pessimistic about China’s deteriorating macro prospects pause. However it is important to note this valuation premium has existed for some years. 

The housing market is an area of particular concern. Estimated to account for ~30% of GDP and up to 35%~50% of the balance sheet at most large banks when accounting for mortgage exposure and loans to developers, the housing market is a core component of China’s economy and housing accounts for approximately 75% of household wealth. While the headlines have been blaring about an imminent bubble bursting in China’s housing market for years the reality is more nuanced. While it’s true that housing has been radically overbuilt in many tier 3-4 cities, the market is still relatively stable in tier 1-2 cities and nationally housing prices declined 0.9% in July versus 0.5% in June. Price growth in major cities like Beijing Shanghai Guangzhou Shenzhen has slowed but is still positive, indicating much of the deterioration is in smaller markets with lower demand. Essentially the market is facing a glut of supply that is not evenly distributed geographically across the country. Before the government started tightening oversight of developers in 2021, many developers, both public and private had been making spectacular profits off this high leverage business model which was also supplying around 40% of local government revenues through land sales. 

Now even formerly respected developers like Shimao are defaulting on their bond payments and stocks of some of the industry leaders like country garden have sold off to all time lows. It’s clear to market participants than many private developers, both public and private, will not survive as their highly leveraged business model cannot cope with 30~40% declines in profits. Conversely, the shares of large state owned developers like Poly Development (600048) remain just off their all time highs as no one doubts the ability of SOEs to continue to procure fresh financing and complete their development projects. 

The slow motion crisis in the property sector is of course exacerbated by the rigid implementation of the zero corona policy, the wisdom of which will not be discussed here. While the policy has been extremely effective up until the Shanghai lockdown in April 2022 at preventing deaths and severe illness, new variants are leading to more frequent lockdowns and greater degrees of uncertainty among households and consumers who are more hesitant to invest and spend. Many consumers and business are adopting a wait and see approach and this is reflected by growing levels of youth unemployment as well as low uptake in new business loans despite the central bank guiding interest rates lower.

China was wise to keep interest rates high over the last several years. Going into this turbulent economic period, the central bank has lowered interest rates to around 3.6% to ease pressure on developers and cheapen the cost of new mortgage loans to house buyers. While this is certainly helpful, the magnitude of the impact is yet uncertain and it may require further time or rate cuts to induce fresh business activity. Meanwhile the government has been setting up stabilization funds for property developers to finish stalled projects and is even guaranteeing the onshore bond issuance for certain property developers like Longfor, among others. 

Manufacturing has been a bright spot in the economy this year as exports have remained strong and even ticked up, but there is a risk that continued sporadic lockdowns may negatively impact supply chains. Chinese manufacturing while still strong could also be hurt by potential recessions in Europe and possibly The U.S.

Overall Chinese policymakers must navigate an unusually complex environment where they have to balance maintaining economic activity against the converse aim of preventing a large scale corona outbreak that potentially causes a mass casualty event and health system overload amongst their large unvaccinated elderly population. It’s likely that the economy could continue to suffer in the short term as the government seeks to continue the corona pandemic controls to prevent a large scale outbreak. It’s also important to remember that while the lockdowns are high profile, at any given time 95%+ of Chinese people are going about their normal daily lives, albeit with drastically less interprovincial travel. 

While the outlook for China’s macroeconomy may seem bleak, it’s important to remember the significant resources the government has at its disposal. Central government debt is only 75% or so of GDP so the authorities could sell bonds to foreigners to raise cash for stimulus (previous overseas bond sales of Chinese government debt have been way oversubscribed and some in Europe even had near zero yields). In a real fiscal and economic pinch, the government could also sell stakes in many large state owned enterprises to raise cash. Most of the larger state owned enterprises are still over 80% owned by the state. Selling off shares in SOEs would be a fast and effective method to raise funds without diluting control, although the state would have to forgo future dividend income for the shares it sells off. 

To conclude on one side there is a slow burn crisis in the housing market where an untold number of developers will fail and banks may have to take large provisions on bad debts. Zero corona policy continues to negatively impact sentiment and the proclivity of businesses and consumers to invest amid such uncertainty. How long this policy remains in place and when (or IF) it is ever removed remains a key question for resuming higher rates of macroeconomic growth. 

What is certain is that the 5% gdp growth target will not be met. However given the substantial tools available to the authorities: more stimulus, interest rate cuts, loan guarantees for developers, it’s possible that China’s macroeconomy can sludge through the rest of this most difficult year, although even maintaining low single digit growth will require walking a tight rope. 


Popular posts from this blog

China's Evolving Equity Capital Markets

There have been many negative media headlines recently about the collapsing stock prices of famous Chinese ADR companies and Hong Kong large caps due to a combination of regulatory uncertainty and in the case of the ADRs, potential delisting by the American authorities. Year to date the Shanghai Stock Exchange SSE 50 Index, which is an index of the fifty largest and most liquid A-share stocks listed in Shanghai, has declined 10% compared to a 20%+ increase for the SP 500. Over the past five years, the SSE 50 Index, as well as other key indices for markets in Shanghai, Hong Kong, and to a lesser extent Shenzhen, have all underperformed the S&P 500. Of major Chinese indices, the Shenzhen 100 Index (SZSE 100), which tracks the largest 100 stocks listed in Shenzhen, has evidenced some of the best performance with a return over the last five years of ~88% compared to ~105% for the S&P 500.   This chart shows the S&P 500 versus the SSE 50 over the past five years and is not adjus

What are Automakers Saying About the Chip Shortage?

The global semiconductor shortage has been much reported on, but few of the major auto companies are able to provide a clear estimate for how much it will affect their manufacturing production in the second half of the year.  First and foremost, the Chinese EV makers, namely Nio, Li Auto, and Xpeng seem to be unaffected by the chip shortage this year. However, these companies have such small scale compared to traditional automakers that it's much easier for them to stockpile chips. In July 2021, Nio delivered 7931 vehicles, up 124% year over year. Li Auto delivered 8589 vehicles, up 251% year over year. Xpeng delivered 8054 vehicles, up 228% year over year. It's likely that these three companies won't face the kind of manufacturing constraints that major automakers are experiencing from the chip shortage, but it will be essential to listen to comments from the respective firm's executives in their upcoming Q2 conference calls.  Larger automakers however are already feel

Global Institutions Increase Investment in China's Largest Luxury Auto Dealer

Zhongsheng Auto (HK:0881) China's largest dealer of luxury cars with approximately 8.1% market share as of the end of 2020, made three important disclosures in the last week that merit the attention of investors eyeing China's auto sector. The first was Zhongsheng's disclosure about new car sales for the second quarter of 2021 and the first half of 2021, available at this link: To summarize, Zhongsheng, a major distributor of Mercedes, Lexus, BMW, Audi, and several other major luxury brands, disclosed aggregate unit sales. At the end of 2020, Zhongsheng operated 373 dealerships, of which 218 were luxury dealerships that are primarily located in tier 1 and tier 2 cities and provincial capitals.  To highlight in the second quarter 2021: Total new car sales volume was 143K, up 15% from the same period last year.  Total luxury car sales volume was 84K, up 21% from the same period last year. For the 1st half, Zhongsheng