China equities – signs of bottoming

An eventual resolution in the real estate sector and power supply tightness would gradually ease market concerns
Chief Investment Office25 Oct 2021
Photo credit: AFP Photo

The second half of the year of the Ox has seen the China market confronted by a number of issues that have resulted in a 30% fall. 

The issues include measures on personal data collection by new economy platform companies, bond defaults by indebted property developers, and the recent power outage situation that impacted supply chains.

In particular, the difficulties encircling indebted real estate developers and tightness in power supply caused economic activities (gross domestic product growth) to slow to 4.9% in 3Q21 from a year ago, compared to 7.9% in the prior quarter. Similarly, growth momentum came to a halt during this period where 2021 sequential growth rates for the first three quarters were 0.2%, 1.2%, and 0.2% respectively (Figure 1).

Figure 1:  GDP growth momentum slowing

Source: Bloomberg, DBS

Countering these near-term headwinds, however, are the bright spots of solid domestic consumption, a strong trade balance, an ample supply of liquidity, and more importantly, decisive moves taken by policymakers to promptly alleviate market concerns (Figure 2).

Figure 2: Strong fundamentals to counter near-term headwinds

Source: DBS

Debt condition on the mend

Before the much-publicised debt debacle of Evergrande (3333 HK), which carried USD300b in terms of total liabilities and USD370b of assets in hand, the fraternity of listed property companies was already in the process of deleveraging. The property developer sector’s ratio of total debt to total asset dropped nearly one-third since 2017, while total debt to total equity improved to 23% (Figure 3).

To show its determination, the government instructed property developers to further lower their leverage ratio to achieve a net debt-to-equity target of 50% by 2023 from 62% presently, which is already an improvement from 88% some years ago (Figure 4). The ongoing improvement will inherently enhance the credibility of the sector.

Notably, the banking sector’s lending exposure to property developers has shown similar improvement. Development loans made up 7.6% of the total banking sector’s loan outstanding in 2Q19 and the ratio has declined to 6.6% (Figure 5).

Figure 3: Decline in developers’ debt

Source: Bloomberg, DBS

Figure 4: Sector’s leverage on the mend

Source: Bloomberg, DBS

Figure 5: Banking sector exposure on development loans manageable

Source: Bloomberg, DBS

Assurance from the central bank

In September, the People’s Bank of China (PBOC) injected USD71b of liquidity into the financial system. In the weeks that ensued, during the height of negative news flow on some property developers defaulting on their bonds, the central bank again stepped forward to ensure availability of capital and that the situation would not become systemic. The government reiterated its stance that mortgage availability will normalise, and financial institutions will continue to extend liquidity to the sector.

Market cheered

On the back of such guidance by the PBOC, the market has staged a steady rebound (Figure 6). We see recent developments to mark the peak in terms of regulatory tightening, hence,  3Q21 and 4Q21 could be the trough of sequential slowdown in China’s GDP.

Figure 6: Signs of China equities bottoming

Source: Bloomberg, DBS

Accounting for 30% of the economy, the real estate industry has been viewed as a perennial driver of growth, and one of the most important and influential sectors in China’s mammoth domestic economy.

It is clear that the government’s intention is to prevent the creation of a property-driven bubble. While it is not the time yet to go all in, we believe an eventual resolution – which is already in progress surrounding debt issues in the real estate sector alongside the issue of power supply tightness – would ease market concerns and induce a forward rerating in China equities.

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