China’s Property Sector
China’s property woes first rattled global markets in September and October, however, fears of systemic risk are resurfacing again. China Evergrande Group, the world’s most indebted developer, has been stumbling from deadline to deadline as it struggles with more than $300 billion in liabilities — $19 billion of which are in international bonds. A $148 million bond payment must be made on Wednesday, and this will be followed by coupon payments totaling more than $255 million on December 28. However new concerns appeared last week when Kaisa Group made a desperate plea to Beijing and creditors for help. Trading in shares of Kaisa and three of its units was suspended after an affiliate missed a payment to onshore investors. In response to Kaisa’s woes, China’s property sector has taken a pounding.
In terms of sales Kaisa Group is China’s 25th largest real estate developer but it ranks second to Evergrande Group in terms of bond repayment bills due next year. This makes Kaisa’s crisis meaningful. Also interesting is the fact that the US Federal Reserve just sent its first direct warning to China and investors about potential global damage from China’s property crisis. In its twice-yearly financial stability report released this week, the Fed wrote: “Financial stresses in China could strain global financial markets through a deterioration of risk sentiment, (and) pose risks to global economic growth.”
It is worth mentioning that economists estimate China’s property sector to be the largest contributor to China’s economy and if related industries are included, property accounts for more than 25% of GDP. Real estate has been a large and steady creator of jobs in the country and land sales account for a third of local governments revenues according to Nomura. Property also accounts for 40% of assets owned by Chinese households according to Macquarie Group Ltd. This suggests that if real estate continues to fall Chinese consumers could lose confidence and curtail consumption. And according to Reuters, the value of nationwide land sales fell 17.5% YOY in August. In short, there is a major risk to the Chinese economy as a result of the current property crisis.
Reuters also notes that due to a long, massive building boom and speculation, China has about 65 million empty homes, or the equivalent of all the households in France and the United Kingdom combined. As of June, Chinese developers owed 33.5 trillion yuan ($5 trillion), or a third of the country’s GDP, up more than two-fold from 2015, according to Nomura. This outstanding debt is roughly equivalent to the GDP of Japan, the world’s third-largest economy. The overriding question is whether or not China will be able to handle the risk that is growing in its property sector. All in all, these developments underscore why investors should not be myopic as the US equity indices make a series of record highs and instead be alert to global issues. Clearly factors outside the US could impact the global banking system, global liquidity and reverberate through the global financial markets. To sum up, China could easily become a major risk for the financial markets in the months ahead.
Assessing the Technical Backdrop
There are many good things happening in the technical backdrop of the market at present. This week the cumulative NYSE advance decline line reached an all-time high confirming the new highs seen in the indices. The Russell 2000 index made a bullish breakout from an 8-month trading/consolidation range which generates a positive outlook for the intermediate term. The daily new high list is averaging 350 new highs per day, and finally, sentiment indicators are oscillating in neutral ranges which means they are not indicating any excess optimism on the part of investors. See pages 9, 11 and 12. These are all positive. The only weakness is seen in volume.
Our first concern is that total volume on the NYSE has been decelerating and has been running below the 10-day average in many November sessions. Volume should increase during advances since rising volume reflects increasing demand. Second, the 25-day up/down volume oscillator has ticked higher but remains stuck in neutral. Currently, the oscillator is at 2.07 and neutral after spending only two days in overbought territory October 25 and 26. To confirm new highs in the popular indices, this indicator should remain in overbought range for a minimum of 5 consecutive trading sessions. The last time this indicator did this and confirmed new highs in the equity market was between February 4 and February 10 of this year. From a technical perspective, this is a sign of underlying weakness, and it is a warning that the bull market is aging.
Still, this is a seasonally strong time for equities. November ranks as the best performing month for the S&P 500 and ranks number two for the DJ Industrial Average. December ranks third in terms of performance for both indices. The other contender is April which currently ranks second for the S&P 500 and first for the DJ Industrial Average. Note that the seasonally strong months tend to coincide with pension funding cycles or tax strategies and IRA funding for individuals. Liquidity is an important ingredient in terms of stock performance; and this good seasonality coupled with a decent technical backdrop makes us optimistic about the next few months. But we see the potential of storm clouds ahead. Not only is China a threat to the global economy and to global liquidity, but earnings growth in the US will fall into single-digit territory in 2022. The great support found in earnings growth this year will not be repeated in the next twelve months. Therefore, a balanced portfolio with companies that are inflation resistant, have strong balance sheets and below average PE multiples remain our preferences.
Economic data is mixed. October’s employment report was encouraging not only because it showed a gain of 531,000 jobs in the month, but because the increase in private industry jobs was significantly higher at 604,000 new jobs. Revisions to two prior months were also positive. In the household survey, the number of people employed grew in excess of the increase in the labor force, which resulted in the unemployment rate falling from 4.8% to 4.6%. Nonetheless, there are 4.2 million fewer people employed currently than in February 2020. See page 3.
October’s ISM manufacturing survey showed that global supply-chain issues are not abating. Most areas were slightly lower but there was an uptick in hiring plans. Conversely, the ISM nonmanufacturing survey was strong, setting a record for the fourth time in 2021. The only blemish in the services report was the decline in the employment index. See page 5.
Vehicles sales increased to 13 million units (SAAR) in October and was below 14 million for the fourth straight month. October’s sales were 21% below a year ago and the lowest October in 11 years. However, sales did rebound from September’s low, and this should help next week’s October retail sales report. See page 6. The NFIB small business survey slipped 0.9 points in October to 98.2, but the real story is that the outlook for business fell 4 more points to negative 37. This was just above the record low of negative 38 set in November 2012. The survey shows both sales and earnings have been sliding since mid-2020. Plans to raise prices jumped from 46 to 51 in October. See page 7.
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