Why Chinese property stocks’ fortunes are finally looking up

Beijing’s forceful measures to stem the crisis in the housing market have contributed significantly to the improvement in sentiment around Chinese stocks
The recovery remains vulnerable without meaningful improvement in confidence in the housing market, but investors have reason to hope

Nicholas Spiro

Published: 4:31pm, 27 May 2024

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It has been a long time since China’s stock market outperformed benchmark global indices in a four-month period. This makes the 26 per cent gain in the MSCI China Index, which tracks Chinese shares listed at home and abroad, since January 22 all the more remarkable.

While the gauge is still down almost 50 per cent from its peak in February 2021, the bull run in Chinese equities has been the big surprise in global markets in 2024. Although several factors are at play – including stronger-than-expected growth in the first quarter, cheap valuations and Chinese stocks’ weak correlation with bond markets in the United States – Beijing’s more forceful measures to stem the crisis in the housing market have contributed significantly to the improvement in sentiment.

Since mid-April, when the rally in Chinese equities gathered momentum, real estate shares have driven the recovery along with internet stocks, a Bank of America report on May 22 noted. The dramatic gains stem from the government’s decision to tackle the property crisis with greater urgency and in a more comprehensive manner than investors expected.

The persistent deterioration in the housing sector has “breached policymakers’ pain threshold, pushing them to step up housing easing and shift the strategic focus towards digesting existing inventory,” Goldman Sachs noted in a report on May 18. Prices for new homes in 70 cities last month fell at their sharpest pace in both monthly and annualised terms in at least a decade.

The package of measures announced on May 17 includes a cut in the minimum down payment ratio for first-time buyers to a record low 15 per cent and a removal of the nationwide floor for mortgage rates. It also provides a framework for reducing housing inventory.

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China’s central bank will offer 300 billion yuan (US$41 billion) in cheap funding to state banks for them to extend financing to local state-owned enterprises (SOEs) chosen by local governments to support the purchase of unsold homes at reasonable prices.

Nomura, one of the most bearish voices on China, said Beijing is “headed in the right direction with regard to ending the epic housing crisis” and “will be the builder of last resort”. While there are serious concerns about the implementation and effectiveness of measures to destock the market, the signalling effect of the bolder policy response sends a message that stabilising the property market is a political priority.

Policy support is now a compelling part of the market narrative around China. The findings of Bank of America’s latest Asia fund manager survey on May 14 show that more investors are buying Chinese stocks on incremental signs of policy easing as opposed to taking a wait-and-see approach.

Yet there are strong reasons to doubt whether further easing measures are sufficient to sustain the rally in property stocks, especially given the dramatic gains over the past month. In a podcast on China on May 22, JPMorgan noted that investors still treat the country’s equity market as “guilty until proven innocent” given the succession of shocks during the past several years.

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This is questionable given the extent to which sentiment has improved. What is clear, however, is that the more forceful response to the crisis in the property market has raised expectations and put the data on housing activity under sharper scrutiny.

Analysts and investors reacted with disappointment to the small size of the relending programme to help reduce housing inventory. The destocking plan only applies to unsold properties that are already completed, doing little to help distressed developers whose projects are mostly unfinished or delayed. Nomura estimates that the funding gap to secure the delivery of pre-sold but uncompleted homes is about 3 trillion yuan.

Another major concern is the scheme’s implementation given that risks are being transferred to local governments and SOEs which are already financially stretched. The unsold homes that will be purchased can only be sold or leased as public housing.

Since average rental yields in tier one cities stood at just 1.4 per cent last year, it is unclear whether the rental income from public housing units will cover local governments’ debt servicing and operating costs, Moody’s Ratings warned in a report on May 21.

Still, the demand-side measures announced by Beijing are significant and should help stabilise sales in the coming months, like when the government reduced down payments and cut rates for existing mortgages in August 2023. Bank of America notes that property viewings in major cities increased markedly after the new measures were announced earlier this month.

Lawrence Lu, managing director and analytical manager, Greater China property and conglomerates at S&P Global Ratings, said it was important to put the easing measures in perspective. “It’s a significant shift in the government’s stance, from removing restrictions to outright stimulus,” Lu said.

The recovery in Chinese equities remains vulnerable. Property stocks are one of the biggest drags on corporate earnings growth. In the absence of a meaningful improvement in confidence in the housing market – especially among homebuyers – and credible solutions to the inevitable snags in reducing inventory, real estate shares are bound to resume their decline.

The stakes are high. A stabilisation in the housing market would encourage retail investors, who dominate trading in onshore shares and have so far stayed on the sidelines, to buy stocks and provide a more solid underpinning to the broader rally. This is why Beijing’s more forceful policy response, although just one of several factors influencing sentiment, offers hope for Chinese stocks.

Nicholas Spiro is a partner at Lauressa Advisory