China property: Stable outlook despite recent market weakness

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1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 China Insights Monthly update on Chinese markets December 2018 Summary Average home prices in 70 major Chinese cities rose to recent high in October, shrugging off concerns over a long-term structural decline The overall cost of funding is set to rise, but policymakers have relaxed onshore funding channels for developers Property developers will repay USD54.5 billion worth of bonds next year, and repayments will rise to a peak level of USD73.6 billion in 2020 but we think the refinancing risk is manageable China property: Stable outlook despite recent market weakness Despite long-running fears over a supply glut, China s property prices have performed relatively better than other onshore investment alternatives over the past few years, although there are some recent signs of cyclical fatigue in the real estate market. To highlight a few recent news headlines, sales by floor area, often used as an indicator of demand, dropped 27% year-on-year in the Golden Week holiday in early October, according to property researcher CRIC. In addition, some developers offered promotions to attract homebuyers including free cars and down payments of as little as 10% of the property price. Some developers even cut the prices by 30%. Property investments have been weakening and developers have left a trail of failed auctions, which were almost unheard of last year. Land auction failure rose significantly during the January-November period, with a failure rate of 6.9%, a peak in recent years. In the latest round of supportive measures, the National Development and Reform Commission on 12 th December said it encourages top-rated property developers to issue onshore debt. Chart 1: Growth in China s property prices moderates This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% Tier-1 Tier-3 Source: NBS data as of Oct 2018, HSBC Tier-2 70-city average

2 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 USDm-equivalent Given its economic importance to the overall economy, we believe that the policymakers would take steps to avoid drastic correction in property prices. To put things in perspective, the value of the country s primary residential property is equivalent to 13% of the country s GDP, and the entire property market contributes 16% directly to the economic output and probably close to 25% if related industries such white goods, steel and cement are included. Looking at the overall market, the slowdown in property prices suggests that the campaign by the central government to clampdown on easy credit has taken effect. On a positive note, average home prices in the country s 70 major cities rose 9.7% in October from the same period a year earlier, higher than September s 8.9% and the highest level since May of last year. However, growth in the average selling price of tier-1 cities edged up 1.2% year on year in October, bouncing back slightly from 1.1% in September and 0.9% in August, according to official data. (See Chart 1) Recent data indicates that overall property prices are still holding up, but there is increasing downward pressure on home prices and sales volumes. For policymakers, the bottom line is to keep housing affordable and rein in prices without imposing a bigger drag on the economy, in our view. Rising funding costs The overall funding environment for property developers in 2018 was tight, due to ongoing slowdown in the onshore public corporate bond market. Meanwhile, the onshore banks have curtailed their lending to developers and have adopted a more conservative approach by providing credit to larger developers over smaller ones. Liquidity conditions for developers in general have weakened, especially for smaller players. Trust financing has increased this year in order to support their liquidity requirements. Yield of one-year trust loans, which have been a key source of funding for property developers during a prolonged period of liquidity squeeze, rose to 10% to 11% area in November, from 8% to 9% over the past a year. The net gearing ratio of the property sector is set to reach 97% this year, up from 88% at the end of last year, while their cash holdings are seen picking up from RMB551 billion to RMB624 billion over the same period. Chart 2: Yield widening of high-yield property bonds We think that most developers have been building up war chests to withstand a structural downtrend from 2019 as the impact of home price restrictions begin to bite. On the other hand, the approval for offshore bond sales has eased, but developers have to pay a much higher price for getting fresh capital from international investors. According to our calculations, the amount of offshore debt issued by Chinese developers has surpassed last year s record of USD42 billion, even though the overall debt issuance in the G3 currencies market was tepid this year. For example, a major developer issued $2.8 billion of US dollar denominated bonds in November though three tranches, with coupon rates between 11% and 13.75% and tenors ranging from two to five years. In contrast, the same company s issuance in June 2017 came with coupon rates between 6.25% and 8.75% and tenors from four to eight years. According to our estimates, developers offshore debt exposure has increased to about 36% of their total outstanding debt, up from 34% at the end of June. That underscores the issuers eagerness to get fresh capital to refinance their debt. Refinancing risk manageable Moving into 2019, we expect the funding conditions to improve as regulatory approvals for onshore debt sales have started to pick up recently. In the onshore space, financing is channeled through private placements and medium-term note. We believe both the onshore and offshore markets will remain selectively open for financially sound developers with refinancing needs. Some smaller developers will have to pay higher refinancing costs because of their limited access to funding and potentially weaker sales over the next 12 months. The amount of total outstanding debt issued by the developers will reach USD54.5 billion next year, and will hit a repayment peak at $73.6 billion in (See Chart 3) In our view, the overall dynamic in the property sector has improved because of government policy fine-tuning and inexpensive valuations. We believe the market has overreacted to the negative news around the sector, which is growing at a slower pace. In terms of the investment in property, we expect demand will slow down from double digit growth this year, dragging transaction volume lower. However, market is well aware of this fact and it has already been factored it into current share prices. As a result, we like blue-chip property developers amidst signs of policy easing. Chart 3: Outstanding debt is manageable 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 China property BB yield China property B yield Offshore China property HY bonds maturities (call exercised) Onshore bonds maturity (put exercised) Source: Bloomberg, HSBC Global Asset Management, data as of 14 December 2018 accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purposes only. Investment involves risks. Past performance is not indicative of future performance 2

3 Equity market Chinese policymakers have plenty of room to maneuver if they need to shore up economic growth and market confidence China stock markets performance was mixed month-to-date (as of 13 December 2018), with MSCI China retreating 0.8% and CSI 300 Index edging up 1.5% respectively. However, the MSCI China Index gained 7.1% in the month of November, outperforming the MSCI EM Index (4.1%). The outperformance was primarily due to renewed optimism among investors after the leaders of China and the United States agreed to meet during the G-20 meeting in Argentina. And the official meeting subsequently led to a 90-day trade truce, prompting global stocks to rally in early December For EM investors, 2018 has been a difficult year as most risk assets have performed poorly. Chinese stocks also fell victim to increased market volatility and the negative impact of rising uncertainty about the US-China trade relationships Valuations remain attractive, with MSCI China now trading at forward price-toearnings ratio of 10.6x, which is a tad below its 10-year average. For most part of this year, valuation de-rating has been the major drag on equity prices, which should rebound given the deflated valuations. Excluding tech-heavy ADRs, MSCI China is trading at 9.3x, which is below its 2-year average of 10.2x In 2019, we don t expect the Chinese policymakers to launch a large stimulus package, but there is plenty of room to maneuver if needed. Given the much more attractive valuations today compared to early 2018, the potential upside can be substantial when new catalysts emerges Earnings estimates for 2018 continue to be revised downward from over 20% in 1Q18 to roughly 11% in early December, reflecting gloomier sentiment on earnings outlook after the 3Q18 reports that generally undershot market expectations On a brighter note, the November new loans rose to RMB1.25 trillion, beating forecasts and up from RMB697 billion in October. The broad M2 money supply expanded 8% in November from a year earlier, matching market consensus. The improvement in November credit supply has strengthened confidence among market players after a surprisingly weak October credit growth sparked concerns that the authorities may be considering more tightening Chinese equities have turned more attractive after recent correction 1-year cumulative total return 30% 20% 10% 0% -10% -20% -30% 12/17 3/18 6/18 9/18 12/18 MSCI China CSI 300 Forward price to earnings ratio (x) /13 12/14 12/15 12/16 12/17 MSCI China CSI 300 Source: Bloomberg, HSBC Global Asset Management, as of 14 December Total return in local currency terms. Investment involves risks. Past performance is not indicative of future performance. Investment involves risks. Past performance is not indicative of future performance 3

4 Sector Comment Consumer Discretionary Consumer Staples Energy We are UW consumer discretionary sector. Policies such as tariff cut and relaxation of foreign ownership dented the outlook for the auto sector. RMB weakness may negatively impact Macau gaming, HK retail and tourism industry in China. We suggest to be selective in consumer staple sector as the trends of premiumisation on the back of rising income underpin higher pricing power and margin expansion capability of selected strong staple brand names We are neutral on energy as oil price may have peaked amid US relaxation on Iran sanctions and market concerns on weakening global demand Financials On the back of a more relaxed monetary policies and continued crackdown of shadow banking. Healthcare Industrials Information Technology Materials We are UW the healthcare space in light of unfavorable policy changes such as increasing imports of foreign drugs and stretched valuation We are neutral to this sector and we like the capital good industry in particular as favourable government policies should prompt higher capex on industrial equipment We are UW the IT sector especially technology hardware due to smartphone sales weakness, limited room for smartphone spec upgrade, and the fact that they could be victims of the US-China trade conflicts We are underweight this sector as softness in fixed asset investment activities suggests soft demand for commodities Property Government is expected to fine-tune its tightening policy to support the sector amid severe external headwinds. Valuations are attractive too. Communication Services Utilities We are selective in this sector. We like major telecoms because of their defensiveness amid the current volatile environment. We also like major internet companies as we see secular growth potential in China s internet space We are overweight the utilities sector because of its defensiveness amid the current volatile environment Source: Bloomberg, HSBC Global Asset Management, as of December 2018 For illustrative purposes only and does not constitute any investment recommendation in the above mentioned asset classes, indices or currencies. The views and opinions expressed herein are subject to change at any time. 4

5 Fixed income Onshore and offshore bonds have returned positively in the past 30 days (as of 13 December), delivering 1% and 0.8% in local currency terms, respectively. On a year-to-date basis, the onshore bonds have rose 7.7% so far this year, while the offshore counterpart edged up 5% for the same period. We are constructive on RMB bonds in general the central bank remains accommodative to support growth China s reserves rose by USD$9 billion in November to USD$3.062 trillion, central bank data showed on 7 th December. The gain was the first since July and compared with a fall of USD$33.93 billion in October Onshore yield curve has continued to move lower as fundamental conditions remain favorable for bonds. Yield on the 10-year government bond reached the lowest level of the year to 3.274% on 10 th December. Onshore corporate bonds also performed well as government pledged more support on financing, mainly for smaller private enterprises. As of December 14, the People s Bank of China has suspended the reserve repo operations for 36 consecutive days, while extending a RMB286 billion worth of medium-term lending facility for another year. That said, the central bank has injected nil net capital into the system over the past six weeks, since its overall liquidity condition remains at a relatively stable level. According to PBoC governor Yi Gang, the country s monetary policy should be relatively accommodative as the economy is under downward pressure, but he stressed that the central bank is taking a balanced approach in its policy. On 14 th December, China reported retail sales expanded at their weakest pace since 2003 and industrial output rose the least in nearly three years in November, underscoring a slowing economic activity. But property investment rose 9.3% in November from a year earlier, accelerating from 7.7% in October, according to National Bureau of Statistics Looking into the Chinese currency, the onshore renminbi against the US dollar advanced 1.1% over the past month, after the leaders of the two economies agreed to a 90-day trade truce. For 2019, we expect the US dollar, which has strengthened by 5% against a basket of currencies so far this year, to stabilize, as investors may start to price in a softer Federal Reserve rate hike path Onshore and offshore yields head in opposite directions 1-year cumulative return 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% 12/17 3/18 6/18 9/18 12/18 ChinaBond New Composite Markit iboxx ALBI China Offshore In the offshore dollar market, a total of 42 Chinese issuers raised USD$15.25 billion of bonds in November, up 11% from October. On a year-on-year basis, the amount contracted by 51% from the same period a year earlier. From our portfolio management perspective, we favor short-dated USD denominated bonds in property sector, given recent policy signals to shore up growth. Source: Bloomberg, data as of 14 December Total return in local currency terms. For illustrative purposes only and does not constitute any investment recommendation in the above mentioned asset classes, indices or currencies. The views and opinions expressed herein are subject to change at any time. Investment involves risks. Past performance is not indicative of future performance % CNH Yld - CNY Yld (RHS) CNH 10Y Govt Yld CNY 10Y Govt Yld 0 bps

6 Data watch Indicator Industrial production (IP) (yoy) Fixed Asset Investment (FAI) (ytd, yoy) Retail Sales (yoy) Exports (USD) (yoy) Imports (USD) (yoy) Trade Balance (USD) CPI Inflation (yoy) PPI Inflation (yoy) Total Social Financing (TSF) (RMB) New yuan loans (RMB) Data as of Actual Cons ensus Prior Analysis Nov 5.4% 5.9% 5.9% Nov 5.9% 5.8% 5.7% Nov 8.1% 8.8% 8.6% Nov 5.4% 9.4% 15.5% Nov 3.0% 14.5% 20.8% Nov Nov 2.2% 2.4% 2.5% Nov 2.7 % Nov 1,519 Nov 1, % 3.3 % 1,350 1, The slower IP growth reflected softer domestic demand/consumption and exports. The purchasing managers survey suggests that IP is likely to remain lackluster in the near term. Economic activity could weaken further into early 2019, due to payback of previous export front-loading and lingering tariff uncertainties despite the 90-day trade truce. We also see downside risk to 2019 growth from weakening property and land markets, while structural headwinds to growth remain. However, policy easing will likely eventually help to stablise the sequential growth momentum with a time lag and we expect pro-growth policy to continue on the monetary, fiscal/tax and regulatory fronts. That said, the room for policy stimulus is constrained by an elevated level of debts and (external) financial stability risks. Recent policy moves have helped a modest investment recovery with infrastructure FAI bottoming out, together with a uptick in manufacturing FAI and broadly solid real estate FAI. New starts and property under construction GFA also picked up, though the former likely have been inflated by some developers need to get financing with new projects as collateral. However, land area purchases and property GFA sales cooled further, probably reflecting weaker momentum in lower-citer cities. Policies remain key to the property market outlook. There has been incremental easing in some cities (e.g. the relaxation of price caps and lower mortgage rates for first-time homebuyers, etc.), although funding conditions for developers generally remain tight. The benefit from new NDRC policy on onshore enterprise bonds may not be significant as it is only applicable for shantytown redevelopment, rental housing and subsidised housing projects and not for commercial property projects, but it is a positive policy signal. We expect policies to be eased with a measured and targeted approach should the property sector continue to show weakness. Meanwhile, we think slower profit growth and trade-related uncertainties mean headwinds for manufacturing FAI in the near term. Infrastructure should remain a key driver for FAI in the coming months, given the central government's policy focus. Nominal retail sales growth fell on lower price inflation, despite the boost from Singles Day online promotion. Real retail sales growth rose to 5.8% yoy from 5.6% in October. Auto sales remained a key drag during a weak housing cycle. The individual income tax cut should help support personal disposable income and consumption into next year, though rising household debt and recent signs of slower employment growth are concerns. The slowdown in export growth came on the back of weaker global demand, lingering US- China trade uncertainties, and a high base last year. The weak imports likely reflected declines in commodities prices, softer demand for processing trade, and still lackluster domestic demand. Import volumes of key commodities, particularly soybeans, coal and iron ore, weakened, although the fall in coal imports was likely due to tightened import regulations until the year-end. While shipments to the US held up, the impact of frontloading caused by expectations for further tariff escalation may be fading. Product-level data suggest that Chinese exports to the US accelerated notably in the months ahead of the tariff implementation but showed significantly afterwards. Chinese imports from the US continued to weaken. US-China trade relations remain key to China s trade outlook. The outcome of the G20 meeting particularly the willingness of the two sides to negotiate and reach a trade deal - has reduced the near-term risk of further escalation in the tariff war. However, the 90-day truce is a short period for negotiations on complicated structural issues, though it could be extended given China s agreement to increase purchases of US goods and its announcement of new guidelines on IP protection and patent law revisions. China is likely to further improve market access for the US/foreign investors. That said, a successful conclusion of negotiations to reach a deal is anything but assured. The lower CPI inflation was primarily driven by a notable decline in vegetable and fuel price inflation, while core CPI inflation stayed at 1.8% yoy. The further easing of PPI inflation was led by falling prices in oil and its related products and non-ferrous metals. Overall inflationary pressures remained moderate amid muted demand pressures despite fluctuations in food prices. PPI inflation will likely continue easing, on softer investment demand and lower commodity prices. The environment protection measures have been loosened in some areas, as the government puts a bigger emphasis on growth stability. Continued (but narrower) contraction of off-balance sheet credit and a fall in net local government special bond issuance (as the full-year issuance quota was mostly used by October) offset the strength of bank loans and corporate bond issuance, resulting a further moderation in TSF growth. However, a recovery in corporate loans by banks and a notable increase in corporate bond issuance possibly reflected recent policies to support corporate credit. We expect the PBoC to keep adequate liquidity in the market and keep market rates low. Providing credit support for the (private) corporate sector and lowering its funding costs via better transmission will likely remain the key monetary policy targets in Indicates improved data on month-on-month/quarter-on-quarter/year-on-year basis Indicates worsened data on month-on-month/quarter-on-quarter/year-on-year basis Indicates no change in data on month-on-month/quarter-on-quarter/year-on-year basis Source: Bloomberg, HSBC Global Asset Management, as of November

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