China’s stock and property markets are top subjects these days. Let’s try to look somewhat deeper into some of their drivers and components.
First I want to make it clear that, in my opinion, the Chinese stock and property markets are overvalued between 50 percent and 100 percent. They could adjust in the foreseeable future around Oct. 1, which is the 60th anniversary of the founding of the People's Republic of China.
Turning points in China are often related to the political calendar. Actually, private investors are again holding to their popular belief that the government won’t let the market drop before that anniversary.
Last time we saw this kind of belief was in October 2007 on the occasion of the 17th Party Congress. Since then we’ve learned the market didn’t take into account that congress date and simply rolled over.
No doubt, in China we have a situation where prices are supported by appreciation expectations. Because of that mindset, more money is sucked in because surging prices supposedly validate these expectations. That, in turn, prompts more people to join the frenzy.
Of course, all these kind of frenzies always end when markets can no longer convince people to come on board. Then we see the collapse of something that has some, if not most, of the ingredients of a Ponzi-scheme.
For now, liquidity in China isn’t a problem. The actual loan-to-deposit ratio stands at 66 percent which is practically unchanged from the 65 percent in December 2008, notwithstanding the fact that loans in China grew by $1.08 trillion during the first half of 2009.
In clear English that means that loans have not been used in the real economy but instead have served as a leverage base for market transactions. China’s asset markets are today in a very big bubble. Simply look at their valuations.
The Chinese stock market currently trades at around 30 to 40 times price-to-earnings. Ignorant local and foreign investors are still jumping in because of an apparent rising momentum. Chinese and foreigners alike are once more, dreaming of getting rich overnight.
As in the past, this category of investors ultimately loses. The final frenzy, which is where I think we’re at, usually doesn’t last.
For property the most important valuations are the ratios of price-to-income and the rental yields. For China, the nationwide average price per square foot is close to the average price in the United States.
Now, U.S. income per capita is about seven times China’s urban per capita income. The Chinese have to pay three months of salary per square meter, probably the highest in the world.
Because of that, a lot of properties can’t be rented out at all as the average rental yield is barely sufficient for compensating property depreciation. This obliges some to argue that China’s property return is exclusively appreciation. We have learned from the past this is not true.
The property market dropped dramatically from 1995-2001. Interestingly, this was during a period of a strong dollar.
Also don’t forget that land prices are manipulated in China in order to drive up price expectations. For example, those who bid extraordinarily high prices for land are celebrated as land kings. Lately, these land kings are often state-owned enterprises financed by state-owned banks.
Of course, they cancel their purchases to local governments who auction the land.
I’m asking myself why these levels of land prices should be meaningful at all. The money simply circulates from one Chinese government pocket into another government pocket. Tomorrow’s non-performing loans, if land prices collapse, which is in the cards, are just today’s fiscal revenues. Private investors, the Chinese, and foreigners who buy or remain in this skyrocketing land market are just playing Russian roulette.
The Chinese stock and property market frenzies won’t last long and the correction could happen in the fourth quarter. If the Chinese authorities inject a second wave of money next year, we could see another frenzy wave. Watch out.
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