Chinese real estate wobble suggests growth slowdown ahead

Mike Riddell
Written by

6th February 2017

Western democracies have garnered most of the attention of markets over recent months, but China’s economy remains a key input – and risk – to the global growth outlook. With the upcoming Politburo in autumn this year, the Chinese government has prioritised a stable economy for 2017.

The delivery of a stable economy in 2017 and beyond would be an astounding success. China’s working age population is now shrinking on most measures, while official data shows its private debt/GDP* ratio is now on a par with Japan in the early 1990s or Spain in 2007 (see BIS data here).   Normally this toxic debt and demographic mix would be expected to contribute to either a dramatic or possibly a calamitous growth slowdown.

To meet their heroic and unsustainable 6.5% GDP growth target, the authorities have resorted to massive monetary stimulus. As highlighted on this blog last May, one measure of monetary stimulus – the M1/M2 money supply ratio – indicates that China has injected greater liquidity into its economy since the end of 2015, than even in 2009-10. This stimulus helped propel Chinese house prices into the stratosphere, with some Tier 1 cities, which are already considered among the priciest in the world, seeing 30% year on year gains.

Critically, there has been strong evidence of a slowdown in China’s real estate since Q4 2016. The chart below shows the percentage of the largest 70 cities seeing price gains (green) and falls (red). We have also included the M1/M2 money supply ratio, where there is a reasonable correlation. (Note that the apparent lag is misleading since M1/M2 is a 3-month moving average of year on year change, whereas China’s real estate prices are monthly.)


Click graph to enlarge

A wobble in China’s real estate market may help to explain some of the slipping in China’s Purchasing Managers’ Index (PMI) data lately, but it has if anything bigger implications well beyond China. Rising property prices encourage greater Chinese construction activity, so changes in Chinese property prices should have a material impact on commodity prices, considering that China consumes about 60% of global iron ore and half of the world’s supply of copper and aluminium. The chart below suggests Chinese property prices do indeed tend to lead global commodity prices, and Chinese imports of commodities in December did slow in volume terms. The BCOM index is a Bloomberg commodity index, weighted by trading volume and world production.


Click graph to enlarge

A wobble in Chinese real estate prices could also prove disinflationary for the global economy. Chinese real estate seems to lead global commodity prices, as shown in the chart above. And commodity prices seem to lead China producer prices (PPI). A paper from the Bank for International Settlements (BIS) in 2014 suggested that Chinese producer prices were the primary driver of the global deflationary pressure seen in the global economy from 2011 until 2016.  Lower factory gate prices in China result in lower manufactured goods prices for the rest of the world, which is something I commented on a few years ago. After 54 months of deflation, Chinese PPI turned positive in November 2016, and many reflationistas have cited this fact as evidence that China is now exporting inflation to the rest of the world (the reality is that China’s 6% devaluation since the beginning of 2016 has offset more than half of the swing upwards in PPI).

Even if commodity prices only stabilise rather than fall, commodity price base effects alone indicate that China PPI is set to drop back from April onwards. To maintain the rate of year on year commodity price increases that we’ll see in March, commodity prices must keep rising by 2% each month, or about 27% through 2017.

Click graph to enlarge

In our funds, we are positioned for renewed market scrutiny on China’s inherent instability, having entered into underweight or short positions in commodity and Asian currencies. At the end of January we added to our duration positions, as China is yet another factor that could put a dent in the huge reflationary/Trumpflation narrative still prevalent in markets, which as we have previously commented is one of the biggest speculative bubbles ever seen.

*Gross Domestic Product

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