Asia/Pacific: Another Spring Scare?
Andy Xie (Hong Kong)
The reflation trade is overbought: investors are again passionate believers in the China-US growth story. They believe that the ‘you buy our bonds, we buy your goods’ equilibrium for the US can last and that China must create sufficient jobs and will and can keep growth going no matter what.
But, a few cracks are appearing. The market is concerned that the Fed may drop ‘the measured pace’ policy soon. Data are pointing to continued serious overheating in China. Its property bubble is causing social tension. China may be on the verge of adopting further tightening measures.
Global financial markets could repeat what occurred last spring. Contrary to the consensus, the Fed was going to raise interest rate in an election year and China was going to tighten. When the market began to unwind the growth-reflation trade, the exit was narrow and markets tumbled. A similar scenario may be brewing now.
What may occur is another scare, in my view. The story is not over until either the Fed and/or China burst their property bubbles.
The Spring Scare Last Year
Nickel doubled in 2004 and peaked at $17,770/ton on January 6, 2004. As the debate on China overheating raged, it trended downwards afterwards and reached $14,220/ton on April 1, 2004. The H-share index for Chinese companies listed in Hong Kong appreciated by 150% in 2003 and peaked at 5,363 on January 2, 2004. The debate on China overheating also pushed it down gradually and it stood at 4,741 on April 1, 2004.
By April 2004, the investor community became comfortable again. The consensus was that China would not take serious measures and the Fed would not raise interest rates in an election year. The market was very long commodities and cyclical stocks and was vulnerable to a shock.
China began to sound tough on macro tightening and stopped the construction of some steel mills in early April 2004. The market also changed its Fed expectation and began to price in Fed rate hikes in an election year. The combination sent the markets reeling. The H-share index tumbled and bottomed at 3,546 on May 17, 2004 or 34% off the January peak, and nickel bottomed at $10,710/ton on the following day or 40% off its January peak.
It turned out to be a scare because China pulled back in the following months on its tightening stance. The government sent a message favorable to growth in September 2004 at the Communist Party Congress. The Fed incorporated the ‘measured pace’ policy together with interest rate hikes, which boosted risk appetite despite rising interest rates. Commodities and the H-share index climbed quickly in response to a more benign environment. The H-share index peaked 5,138 on March 1, 2005 and has been tightly range-bound around 5,000, and nickel peaked at $16,565/ton on March 8, 2005 and has been trading tightly around $16,000/ton.
The Looming China-Fed Tightening Cocktail
The January-February data indicated that China was still overheating seriously. At the just-concluded National People’s Congress, delegates expressed serious concerns about the property bubble. The Chinese government appears to be under pressure to adopt further tightening measures. Another rate hike and anti-property speculation measures could be introduced soon.
The market is increasingly concerned that the Fed may drop the ‘measured pace’ in its policy soon. The 10Y Treasury yield has risen by over 40 bps in the past four weeks. The sharp spike up began with Mr. Greenspan’s comment on the conundrum over a booming stock market and low Treasury yield. While greed still dominates most markets in the world today, there is considerable concern in the US Treasury market now. This concern could spread if the Fed does drop the ‘measured pace’ in its policy statement.
Most markets are still very optimistic about growth. Concerns (e.g., the US trade deficit, big property bubbles everywhere, Mr. Greenspan retiring soon) over the growth sustainability have shadowed the market for some time. Most investors have become numb to such stories and, as the world is still booming after such stories have been around for so long, believe that the status quo will continue regardless. The January 2006 retirement date for Mr. Greenspan is still quite distant for most investors. The market, therefore, is betting heavily on commodities and cyclical stocks.
The rising pressure on China and the Fed to tighten and a complacent investor community make markets quite vulnerable in the short term. When China and/or the Fed announce policy changes, it would be a big shock for the market. The unwinding could be quite frantic.
The End Game
What may occur soon is another scare, in my view. Property bubbles support demand in the US and China. Until property prices begin to decline in New York and Shanghai, the game is not over.
Household real estate values in the US increased by $2 trillion or 13.4% in 2004 compared to $1.4 trillion or 10.5% in 2003. US personal consumption rose by $505 billion in 2004. On the surface, the balance sheet of the US household sector is much stronger than one year ago due to asset inflation. As long as property prices keep appreciating at the current pace, why should the US consumer stop spending and start saving?
Strong US consumption has kept China’s exports strong. Hot money continues to pour into China. China is not investing all the money that it has. The surplus liquidity in the banking system is very high. China’s property sector continues to expand rapidly. Over the past three years, property prices have doubled in major cities in the Yangtze Delta region and increased by 60% in most provincial capital cities. The sales of new properties reached 7.4% of GDP from 4.7% three years ago and 2.1% in 1997. New property projects have been growing at 15% per annum in square meters in the past three years. The properties under construction, when completed, are worth more than one-third of GDP at current prices. As most developers expect double-digit price increases, the inventory-carrying profit is expected to exceed 3% of GDP per annum. The profits of S&P 500 companies are only 3.5% of the US’s GDP. This is why the investment desire is so strong in China.
The consumption dynamic in the US or the investment dynamic in China won’t change until the property markets turn down in either or both. Hence, when investors want to assess if a day of decision for property is here, it is best to look at New York or Shanghai property prices.
morganstanley.com |
