Evergrande’s Just The Start. China’s Property Blitz Could Have Even More Dramatic Consequences.

Evergrande’s Just The Start. China’s Property Blitz Could Have Even More Dramatic Consequences.
Reda Farran, CFA

over 2 years ago4 mins

  • China’s property sector – which for decades has fueled the country’s economic growth – is now under pressure as it aims to rein in debt, address a chronic oversupply, and bring prices under control.

  • A drastic slowdown in China’s property sector will lead to a major slowdown in China’s economic growth rate, which will, in turn, send ripples through global markets.

  • Global government bonds would do well in such a scenario, while commodities, stocks in economically sensitive sectors, and those in Asian emerging markets might suffer.

China’s property sector – which for decades has fueled the country’s economic growth – is now under pressure as it aims to rein in debt, address a chronic oversupply, and bring prices under control.

A drastic slowdown in China’s property sector will lead to a major slowdown in China’s economic growth rate, which will, in turn, send ripples through global markets.

Global government bonds would do well in such a scenario, while commodities, stocks in economically sensitive sectors, and those in Asian emerging markets might suffer.

Mentioned in story

China’s property sector might have fueled the country’s economic growth for years, but it’s suddenly found itself under serious pressure. And with the government’s new measures having already claimed property giant Evergrande as a victim, they’re bound to have even further-reaching consequences – on the country’s property market, its economic growth, and global markets at large – that any investor needs to be wise to.

Consequence #1: A drastic slowdown in China’s property sector

The Chinese government is making an example of Evergrande to show other property developers that it’s very serious about the “three red lines” it laid down last year. These red lines were implemented to reduce debt levels in the property sector and rein in a chronic oversupply of residential real estate.

According to Hong Kong-based research firm Rhodium Group, there’s enough empty property in China to house over 90 million people. You could fit the entire population of Germany in that empty space. The government is serious about tackling this massive oversupply problem, which means there’s likely to be a significant drop in property investment and construction – and, in turn, a dramatic slowdown in the sector.

Making matters worse is that China’s property market is also contending with falling demand. After almost three decades of hundreds of millions of people leaving villages to settle in cities, the biggest migration in human history has now dwindled to a trickle. Some experts are even predicting that falling birth rates will push China’s population into absolute decline, dampening demand for property even more.

Consequence #2: A drop in China’s economic growth rate

China’s vast property sector makes up around 30% of the country’s economy – considerably higher than is typical in other countries. So its drastic slowdown up ahead will strike at some of the vital organs of the Chinese economy, potentially depressing economic growth for years to come.

According to the chief China economist at investment bank Nomura, China’s annual growth rate will drop to 4% or lower between 2025 and 2030. That’s a far cry from the average annual growth rate of 10.4% and 7.7% the Chinese economy experienced during the 2000-2009 and 2010-2019 decades respectively, suggesting the Chinese “growth miracle” is in peril.

The government will try to offset its over-reliance on real estate to more preferred engines of growth, like high-tech manufacturing and green infrastructure (think renewable energy projects and EV charging stations). But net-net, China’s economic growth rate is still expected to drop significantly. So perhaps the narrative change towards “common prosperity” is a calculated way for a drop in economic growth not to be perceived as a failure by the government.

Consequence #3: Ripples through global markets

A drop in China’s economic growth rate will send ripples through global markets, which are worth monitoring to avoid potential investment losses – or even to create profit-making opportunities.

China has long been the biggest engine of global growth, contributing 28% of growth worldwide from 2013 to 2018 – more than twice the share of the US – according to a study by the International Monetary Fund (IMF). So a slowdown in China’s economy will almost certainly lead to a slowdown in the global economy.

In that scenario, global government bonds should do well because investors tend to swap stocks for more dependable returns during periods of falling economic growth. Central banks may also lower interest rates to help stimulate the economy, making existing bonds more attractive and helping push their prices up.

On the flip side, falling economic growth means less demand for resources and lower commodity prices, which doesn’t bode well for the asset class. It rarely bodes well for stocks either, but some are much more at risk than others: those that are most economically sensitive and globalized like industrials, basic materials, energy, and so on.

Take US industrial firms, which, according to estimates from JPMorgan Chase, have around 10% sales exposure to China. The investment bank reckons the most at risk include General Electric, Otis Worldwide, Honeywell International, and Caterpillar.

Another example is British basic materials companies: according to Bloomberg, China accounts for 62% of revenue at BHP Group, 58% at Rio Tinto, and nearly half at Anglo American and Glencore. Cement makers as well as building suppliers in Europe like HeidelbergCement, Kone OYJ, and Schindler Holdingwill also be directly affected by the Evergrande fallout, according to investment bank Liberum.

Finally, another way to look at stocks most impacted is not by sector, but by geography. China’s economic growth rate is seriously important to emerging economies in Asia, including South Korea, Taiwan, Singapore, Malaysia, the Philippines, and Vietnam. So a slowdown in Chinese economic growth could lead to an even bigger slowdown in these countries’ growth rates, which certainly doesn’t bode well for those countries’ stock markets.

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