No contagion risk from China

Stay constructive on risk assets. Prefer DM over EM as the Fed begins to taper
Chief Investment Office23 Sep 2021
Photo credit: AFP Photo

Not a “Lehman moment” for China – Limited global impact arising from Evergrande’s fallout. Investor’s concerns on real estate developer China Evergrande (3333 HK) have roiled financial markets as the firm teeters on the edge of default. The concerns are not without reasons. Afterall, Evergrande’s debt of c.USD300b constitutes c.2% of China’s gross domestic product. In other words, Evergrande is “systemically important”, and its potential collapse would have spillover effects in other parts of the economy.

However, we do not subscribe to the view that this represents a “Lehman moment” for China. Unlike a hedge fund or investment bank with massive leveraged positions and counterparty risks, Evergrande is ultimately a highly geared property company with a far simpler operating structure. Its impact on global financial markets will be limited for the following reasons:

-   Moral hazard vs financial stability – striking a fine balance: Taming real estate speculation and capping property prices is part and parcel of China’s pursuit of “common prosperity”. But given that real estate accounts for c.25% of China’s economy, it is unlikely that the government will allow the sector to fall into a tailspin and cause material harm to the economy. Instead, the government will strike a fine balance between reducing moral hazard and maintaining overall financial stability. Should the situation deteriorate further, we expect the People’s Bank of China to step up and loosen liquidity.

-   No signs of steep correction in China property prices: In order for the Evergrande saga to have knock-on effects on the broader economy, a steep correction in property is necessary as the latter will materially impact the collaterals held by the banking system. However, this has not been the case. On a year-to-date basis, average prices in Beijing and Shanghai have grown by 7%.

-   An uncrowded trade – global portfolios substantially “Underweight” on China: Amongst global equity mandates, “proxy” benchmark weight for the United States stands at c.52.0% while the allocation to China is only c.2.9%. But even at this level, prevailing active allocation to China is only 1.7% and this constitutes an Underweight position of 41%. The insignificant representation of China equities in global mandates suggests that global portfolios will unlikely suffer acute drawdowns should the Chinese real estate situation deteriorates further.

Stay constructive on global risk assets; Prefer DM over EM. We believe that the Evergrande episode will have limited impact on global risk assets, and we maintain a constructive stance given ongoing corporate earnings strength and benign monetary policy environment. On a geographical basis, we maintain our preference for Developed Markets (DM) over Emerging Markets (EM) as the Federal Reserve begins to taper.

Figure 1: Chinese property prices remain stable; Global portfolio allocators are Underweight on China

Source:  Bloomberg, EPFR Global, DBS, *Note: Based on ETF weights


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