Squeezing The Largest Asset Class On The Planet

Over the past six months, copious amounts of digital ink was spilled on China’s escalating regulatory crackdown and the ramifications for assets of all kinds, with an initial emphasis on equities.

The focus on equities was understandable given the genesis of the reform effort. It started with an antimonopoly push which, notwithstanding the usual ambiguity associated with Party capriciousness, was overtly bearish for China’s tech titans. As the crackdown expanded, the losses piled up, eventually cutting the Hang Seng Tech gauge in half.

Nearly a year on from Jack Ma’s “big mistake” (as I’ve called Ma’s criticism of regulators during an infamous address in Shanghai last October), Beijing’s antimonopoly initiative has metamorphosed into a societal overhaul under the banner of “common prosperity.” Everything is seemingly in play. Nobody is safe. Or at least that’s the market’s take.

In a new note, Goldman reiterated that the current regulatory tightening cycle is “unprecedented in terms of its duration, intensity, scope and velocity.” The bank’s regulation proxy tells the story (updated figure below).

Beijing’s property crackdown is intertwined with the regulatory push. Indeed, you could suggest they’re inseparable. The last two weeks demonstrated why that’s potentially perilous.

The property crackdown represents a clear and present downside risk to growth. As we’ve seen with the Evergrande saga, the knock-on effect to sentiment can be substantial and poses significant spillover risk on its own, even if there’s no actual contagion. Sentiment doesn’t need a tangible “event” to sour — fear alone is enough. Just ask last Monday, when US equities careened sharply lower in part due to Evergrande jitters.

Given the size and importance of the property sector in China, it’s probably not accurate to call the interplay between the property curbs and Evergrande a microcosm of the interplay between the broader regulatory crackdown and myriad market outcomes precipitated by the deluge of decrees targeting everything from food delivery to education technology. It’s the same general dynamic, though. There’s a tangible and, in some cases, quantifiable, risk to growth and earnings, which is ostensibly manageable. Evergrande can be ring-fenced, for instance. And then there’s an unquantifiable risk to sentiment associated with the ambiguity and enormity of it all. That can’t be managed as easily because it’s psychological.

Market participants marveled at the scope of the losses in Chinese tech. As Goldman’s Kinger Lau wrote, “regulatory actions have resulted in more than $1 trillion in market cap loss on the tech sector since mid-February.” I’d argue the vast majority of that was attributable to uncertainty, not to any projections or models re: what “common prosperity” might entail for tech profits.

Now, consider the property sector. Lau cut Goldman’s 2022 EPS growth forecast for MSCI China from 13% to 7%, citing a “lower property growth impulse,” but he cautioned that “it could fall to -15%” if the bank’s economists’ bear case plays out. That’s a pretty substantial deviation from the base case to the bear case.

The bank elaborated, noting that on their estimates, the housing sector contributes around 20% of GDP, while as much as 15% of aggregate market earnings “could be exposed to ‘property demand.'” Meanwhile, property-related loans represent more than a third of banks’ loan books, and developer bonds comprise nearly a quarter of the outstanding balance of offshore USD credit.

To be sure, those numbers won’t come as any surprise to China analysts, but they might to the general investing public. Even more notable is the figure (below), which suggests the Chinese property market is the largest asset class on the planet.

Again, I want to emphasize that this won’t be “news” to some readers, and especially not to anyone who follows the Chinese economy. But as I was sorting through today’s digital pile of research, I came across the chart (above) and felt obliged to somehow work it into an article.

As Goldman put it, we’re witnessing “unprecedented regulatory tightening in the largest asset class globally.”

Two years ago, the size of China’s residential housing market was around $40 trillion. Now, it’s $60 trillion when you count inventory. As of last month, property accounted for nearly two-thirds of household assets.

The phrase “It’s impossible to overstate the case” is probably overused. And we don’t often mean it literally. Here, though, it may be applicable in the most literal sense.