Is Now the Time to be Bearish on China?
One of the world’s largest hedge funds has turned bearish on China, arguing that the recent stock market correction means ‘‘there are now no safe places to invest’’ in that country. I disagree. I respect Bridgewater as an investment house and their views require serious attention. But I think it worthwhile to explain some areas where my views differ.
In their nine-page research note, Bridgewater Associates acknowledged that they were surprised by recent volatility in China’s A-share market. Two decades and more of experience have taught me, and Matthews Asia, to look beyond the volatility of China’s stock markets and look at the long-term opportunities.
The first place where I disagree is with Bridgewater’s characterization that China’s “stock market was in a bubble that has burst.” Bridgewater’s note was published on July 21st, and as of that date the main A-share index, the Shanghai Composite, was down 22% from its June 12th peak. But that index was also up 24% from the start of the year and was up 96% from a year ago. Hardly, in my view, the level of correction that is likely to, as Bridgewater writes, ‘‘have a depressive effect on economic activity.’’
Small Scale of Chinese Investors
The hedge fund reports, accurately, that ‘‘the percentage of the population that is invested in the stock market and the percentage of household savings invested in stocks are both small.’’ There are about 50 million active individual investors in China, which is equal to only about 4% of the total population or 7% of the urban population.
And most Chinese investors are punting a fairly small amount of money. As of last November, 69% of individual investors had less than the renminbi (RMB) equivalent of US$15,000 in them, and less than 1% of accounts had more than US$1 million. Very few Chinese are likely to be betting anything close to their life’s savings, and I imagine all of them are aware of recent history: in 2007, the A-share market rose even more sharply than this year, and then in early 2008, it crashed hard. (It is also worth noting that foreigners account for only about 3% of A-share holdings.)
Another interesting indicator is that as the market soared this time, the growth rate of bank deposits slowed only slightly, to an average of 10.4% year-on-year (YoY) during the second quarter of 2015, from 11.4% during the same period a year ago, before the market took off.
Bridgewater argues that “even those who haven’t lost money in stocks will be affected psychologically,” leading to a significant economic downturn. Again, I disagree.
Stock Market is Not the Economy
First, it is important to recognize that the market did not fall because of macro problems. Yes, China’s GDP growth rate is slowing, and I expect it to continue to decelerate gradually for many years. I’m very bullish on the country’s economic prospects, but expect GDP growth to cool to 5% to 6% by 2020. That is still very fast growth, on a very big base, and today, China’s job market is stable and real (inflation-adjusted) retail sales rose 10.6% YoY in June, the fastest pace in four months (despite the A-share market having peaked on June 12th). Online retail sales of goods rose 39% YoY during the first half of the year.
Second, even including margin trading, Chinese household debt is very low and savings very high. Household bank deposits are the RMB equivalent of US$8.5 trillion, which is greater than the combined GDPs of Russia, Brazil, India and Italy.
Little Wealth Effect
And it is worth noting that in the 12 months after the 2008 A-share crash, real retail sales rose at a faster pace than during the 12 months when the market was booming. I do not expect retail sales to re-accelerate this time, but this historical comparison is another reason to believe that a continued market decline will not result in a collapse in consumer spending. Market participation in China is so low that there was not a significant wealth effect when A-shares were hot, so there isn’t likely to be a significant negative wealth effect on the way down.
Bridgewater worries about the “mutually reinforcing negative forces on growth” from “debt restructurings, economic restructuring, and real estate and stock market bubbles bursting all at the same time.” I’ve written detailed reports on each of those topics for our investors, and can offer a summary here.
China suffers from a serious case of “debt disease,” but the treatment and side effects may not be as severe as some expect, and dramatic credit tightening is very unlikely. Debt is concentrated among state-owned firms, while the private firms that generate most of China’s new jobs and investment have already deleveraged. And China’s foreign debt exposure is low, steady at less than 10% of GDP since 2008. This is a sharp contrast to Thailand’s 62% ratio in 1996, ahead of the Asian Financial Crisis. By funding its infrastructure build-out domestically, rather than through foreign lenders, China has avoided one of the key problems that contributed to past emerging market debt crises.
Economic restructuring continues, and although it will continue to lead to steadily slower growth, this is both healthy and expected. This is likely to be the third consecutive year in which the tertiary part of China’s economy, which includes services and consumption, will be larger than the secondary part, which includes manufacturing and construction. Consumption accounted for 60% of China’s GDP growth in the first half of this year.
Finally, China’s 9% average annual growth in residential property prices over the past 10 years may appear to be the hallmark of a bubble, but that was accompanied by 12% average annual nominal urban income growth.
Unprecedented Income Growth
Unprecedented income growth not only supports China’s remarkable consumption story, it also underpins a healthy property market. Over the past decade, inflation-adjusted urban income rose by 7% or more every year, while real rural income increased by 7% or more during each of the past nine years. In contrast, over the past decade real income rose at an average annual pace of 1% in the U.S. and 0.3% in the U.K.
In my view, an important precondition for a bubble in any asset class is a high level of leverage, because in the absence of high leverage, the consequences of a sharp price decline are limited. In China, there is extremely low leverage among homebuyers because about 15% of buyers over the past three years paid all cash, while for those using mortgages a minimum cash down payment of 30% is required. That’s quite a difference from the 2% median cash down payment made by American homebuyers in 2006. And, Chinese banks have not been permitted to offer subprime mortgages.
Today, the property market is soft, but it is far from the collapse that many are writing about. June, in fact, was the second consecutive month of double-digit growth in new home sales, the first time that has happened since late 2013. New home prices are down about 6% YoY, compared to an increase of about 4% a year ago, but given that Chinese homebuyers are required to use a lot of cash, even steeper price declines would leave very few mortgages under water.
The boom days of China’s property market are, however, over. But this more mature market is far from a disaster: Chinese are still likely to buy about 10 million new urban homes this year, almost double the number of combined new and existing home sales in the U.S. last year.
Volatile but Opportunities
While Bridgewater believes “there are now no safe places to invest” in China, for active, long-term investors like Matthews Asia, we see opportunity. Even as China slows, it is likely to remain one of the world’s fastest-growing economies, and I also expect it to remain the world’s best consumption story.
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