The Good, The Bad, The Ugly: Three Potential Outcomes For The Chinese Property Market, And How To Profit From Them

The Good, The Bad, The Ugly: Three Potential Outcomes For The Chinese Property Market, And How To Profit From Them
Stéphane Renevier, CFA

over 2 years ago4 mins

  • If you think the Evergrande situation is much ado about nothing, invest in Chinese stocks via certain ETFs.

  • If you think Chinese authorities will try to strike a balance, you could bet that infrastructure, renewable energy, and semiconductors/5G will outperform the likes of home appliances and jewelry makers.

  • If you think global contagion is a real possibility, you might want to short the Australian dollar versus the Japanese yen, or buy put options on the high-yield ETF.

If you think the Evergrande situation is much ado about nothing, invest in Chinese stocks via certain ETFs.

If you think Chinese authorities will try to strike a balance, you could bet that infrastructure, renewable energy, and semiconductors/5G will outperform the likes of home appliances and jewelry makers.

If you think global contagion is a real possibility, you might want to short the Australian dollar versus the Japanese yen, or buy put options on the high-yield ETF.

The Chinese property market has been going through a tough time of it lately, and no one knows exactly where it’s headed next. But three scenarios – one good, one bad, and one downright ugly – seem the most likely, and there’s a way to profit whichever one you think is most likely…

The good: China’s government steps in

Here’s the thing: Chinese real estate stocks have been reflecting the deterioration in the property market for months, with the main indexes dropping double-digit returns since their high in March. The Evergrande debacle has simply accelerated the fall, bringing price-to-earnings (P/E) ratios of property stocks to levels similar to their previous troughs (see the dark blue line in the chart below). And while the P/E ratio for the overall Chinese market hasn’t dropped as much, it’s still corrected significantly in the last few months (light blue line).

A lot of bad news is already priced in
A lot of bad news is already priced in

In other words, plenty of the bad news we’ve been hearing around Evergrande and the wider property maker is already reflected in the stock market’s price. And if the authorities step in – and there are plenty of reasons they would do – you could expect a significant relief rally, at least in the short term.

How do you bet on a relief rally?

The easiest way would be to buy a China or Hong Kong ETF, such as the iShares MSCI China ETF (ticker: MCHI) or the Franklin FTSE Hong Kong ETF (ticker: FLHK). But it wouldn’t be the cleanest expression of the view, as those indexes are largely driven by the technology sector, which may not benefit as much from authorities stepping in. A much cleaner – if riskier – trade would be to buy the Global X MSCI China Real Estate ETF (CHIR), which is down more than 30% from its previous high.

The bad: China’s government tries to strike a balance

The impact from a deterioration in property markets could easily go beyond property developers and hit everyone from home appliance makers (less construction = less home appliances) to jewelry makers (property prices down = household wealth decrease = less money to spend on a fancy ring).

In any case, one thing is certain: you can expect the Chinese authorities to try and balance the blow to growth by stepping up their support of their championed sectors, such as infrastructure, renewable energy and semiconductors.

There are three ways to play that scenario: short the losers, buy the relative winners, or do both.

Note that this third case is a relative value view, meaning that rather than betting on a market rebound or further fall, you’re betting that certain sectors will outperform other ones. That should allow you to make money in both up or down markets.

How do you bet on the winners and against the losers?

Research provider TS Lombard identified China Railway Group, China Tower, and ZTE Corp as the stocks that might benefit the most from increased infrastructure spending.

To play the renewable energy and semiconductors themes, you could have a look at the KraneShares MSCI China Clean Technology Index ETF (ticker: KGRN) and KraneShares CICC China 5G & Semiconductor Index ETF (ticker: KFVG).

On the short side, TS Lombard reckons Luoyang Glass Co (a flat glass manufacturer), Royale Home Holdings (home furnishing products) and Haier Smart Home Co (appliance manufacturers) could be attractive short candidates. I’d add two more to the list: Chow Tai Food Jewellery group (a jewelry manufacturer) and Hangzhou Robam Appliances (a premium kitchen appliance manufacturer).

The ugly: Things spiral out of control and contagion sets in

Chinese authorities might just decide not to step in. And even if they do, there’s no guarantee they’ll be successful in limiting the damage. Chinese real estate is the largest asset class in the world, and any deterioration in the sector could quickly spiral out of control and spread to the global financial markets.

It doesn’t look like the market’s worried enough about that risk either, with high-yield credit spreads – that is, the “premium” investors require to hold risky debt – having barely moved over the past few weeks. In other words, one of the most accurate barometers of global contagion is yelling that global contagion could be exactly what we’re headed for.

How do you bet on global contagion?

The Australian dollar (AUD) – a currency tightly linked to Chinese’s growth – should depreciate versus the Japanese yen (JPY), a defensive currency that tends to do well in difficult environments. So buying the AUD versus the JPY is the first play.

If you’re feeling really bearish, a trade with an even higher asymmetry could be to buy put options on the US High-Yield ETF (ticker: HYG ETF). The chart below shows quite clearly the decoupling between the Chinese real estate market (blue line), the AUDJPY (turquoise line), and the US high-yield market (yellow line).

AUD/JPY and HYG ETF have some catch up to do
AUD/JPY and HYG ETF have some catch up to do

So if the contagion spreads more globally, the AUDJPY pair and the HYG ETF could catch up big time on the downside.

Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG