The Hot-Air Model of Chinese Asset Markets

Chinese regulators are cracking down on stock and bond speculation. Real-estate markets are, however, suddenly doing just fine. This is unlikely to be a coincidence.

By Nathaniel Taplin

Talk to any young adult in a big Chinese city and the subject of yali, or pressure, will quickly come up. China is without a doubt a high-pressure society: Inequality is intense, pollution and traffic are often unavoidable and family obligations can be overwhelming.

A high-pressure environment is a good metaphor for Chinese markets too. Because of the nation’s capital controls, investment options are limited—and regulatory crackdowns have a tendency to push leverage around rather than get rid of it. The curious resurgence in 2017 of Chinese property prices, which spent most of late 2016 slowing only to shoot upward again in February and March, looks to be another example of this dynamic at play.

The property market rebound has coincided with two big domestic policy developments. First, as the economy has improved, regulators have become increasingly vocal about financial market “deleveraging,” though actual reduction or leverage ratios is unlikely. A two-year high in interbank interest rates, engineered by the central bank, has rattled bond markets and cut off an equity rally.

Meanwhile, stricter capital controls have helped choke off capital flight: Following two years of declines, China’s foreign-exchange reserves began rising again in February. Domestic credit growth has slowed, but remains elevated. Total financing to the real economy (including local government debt) was up more than 15% on the year in March, just marginally below the 17% peak in 2016.

All that money needs somewhere to go. And with stocks and bonds under pressure, and sending money abroad to buy Italian soccer clubs and dollar bonds getting tougher, cash is instead heading back into Chinese investors’ old standby: real estate.

If the renewed momentum in the property market were sustainable, that would be a big shot in the arm for China. The problem is that all the money being squeezed into real estate and out of stocks and bonds could just as easily run out once the current crackdown loses steam and regulatory spotlights focus again squarely on curbing real estate speculation—as they did toward the end of 2016.

And the fundamentals for Chinese property look more mixed than justified by the recent price rally. Actual real-estate investment ticked up marginally in March to 9.4% growth on the year, but remained well below its October 2016 peak of over 13%. Steel and other commodity prices have also been under pressure in recent weeks, raising questions about the strength of real demand in China, which consumes around half the world’s steel. Weak purchasing managers indexes out this week add to these worries.

Too much pressure inevitably leads to cracks.

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