Investment Strategy

China: Navigating a real estate rescue and renewed trade tensions

May 23, 2024
Authors: Alex Wolf, Julia Wang, Cynthia Chou, Yuxuan Tang 


The latest housing policy measures are a step in the right direction, but the scale remains insufficient and the implementation is challenging. If additional policies are rolled out the growth outlook would improve modestly next year. On tariffs, the impact will likely be differentiated by sector and we do not expect significant retaliation from China, though an escalation with Europe could materialize and would be impactful.

We expect slightly higher multiples on more positive market sentiment but continue to prefer onshore equities and fade offshore exposure. Valuations no longer look distressed and the risk-reward is looking increasingly unfavorable. We see better value in the onshore market for long-term investors.

 

China recently faced two conflicting developments – on the positive side, new policies were announced to support the ailing property sector; on the negative side, the U.S. administration announced a new set of tariffs on Chinese imports. On net, the market focused on the positives. Chinese stocks continued their rally, led by a surge in property-related stocks. MSCI China is now up around 30% since its January trough, led entirely by improved sentiment that has driven valuations higher, while fundamental earnings expectations have actually trended lower. 

We’ll unpack both of these developments and assess their likely impact on the economy and markets. These two policy developments, though seemingly unrelated, are in many ways interconnected. Domestically, China is attempting to steer the economy towards new sectors and away from real estate, but as the country moves heavily towards sectors like electric vehicles, it risks creating substantial excess capacity (and it might already be there). The tariffs are an attempt to preempt a flood of exports in strategic sectors and give the U.S. industries time to diversify their suppliers. 

This is likely just the beginning on both fronts. More announcements are expected from Beijing to support the economy, and the trade landscape is likely to continue shifting as major Western economies reassess their trade relations with China. 

Recent policy announcements may signal the beginning of the end for China’s historic housing bust. To put some context around the property sector and impact of its fallout – at its peak in 2020-21 the sector contributed 25% of GDP and 38% of government revenue. Despite falling prices, property may still account for more than 65% of Chinese household wealth. After hitting a historical high in 2021, the sector experienced a downturn, with new home sales in April 2024 down 60% from 2021. The dire situation has significantly curbed developers’ willingness and ability to acquire land, which has impacted local government finances, many of which depend on land sales revenues. With reduced land purchases by developers, new home starts in April 2024 slumped 69% from historical highs in 2019.

Only the central government appears to have the capacity and authority to stem the real estate slump, given the scale of challenges being faced: 

  • There is a significant amount of pre-sold but unfinished homes.
  • Developers have a large inventory of finished but unsold properties.
  • Since land sales and property-related taxes make up 38% of local governments’ total revenue, the contraction in land sales has severely worsened local fiscal conditions.
  • Housing prices have begun to dip, with no sign of stabilization. Falling housing prices reduce a household’s willingness to purchase property, which could lead to even lower prices.

The policies announced on May 17th have two key elements.

  1. Lowering downpayment and mortgage rates. The minimum downpayment rate for first and second-time homebuyers has been cut from 20% to 15% and 30% to 25% respectively. The minimum mortgage rate requirement has been removed, and the provident fund mortgage rate has been cut by 25bps.
  2. RMB300bn special facility. This facility is provided by the People’s Bank of China (PBoC) through commercial banks, and enables local governments to purchase completed but unsold properties for conversion into affordable housing, based on demand. This scheme can be leveraged up to RMB500bn. The facility has an interest rate of 1.75% for one year and is extendable for four years. There are other minor measures – such as continuing the ‘white list’ to support projects under construction, and buying back idle land.

We think the first element is relatively straightforward. There has been a steady stream of measures enacted by local governments over the last six months aimed at lowering mortgage rates, downpayment ratios and relaxing home purchase restrictions. The problem is lack of demand, not high rates or downpayment requirements. Generally prices need to adjust further to encourage buyers back into the market. We therefore think it’s unlikely to result in an immediate sales recovery. That said, the cumulative effect of lower interest rates coupled with ongoing improvements in affordability (lower rates and potentially lower prices) will likely translate into a stabilization of potential demand over time. 

As for the PBoC’s special facility, this scheme represents a shift in the policy approach to the housing crisis. We think focusing on de-stocking and using the PBoC balance sheet could be an effective strategy, but the scale is too small to turn around the housing market. We estimate the scheme could help reduce the supply of finished but unsold housing by about 20%. However, when we use a broader concept of inventory that includes floor space under construction, the program can only purchase at most 5% of this much broader stock of supply. On its own, the scale is unlikely to have a meaningful impact on inventory levels. In addition, implementation is complex given the need to balance the economics of rental housing, local government debt dynamics, as well as supply and demand mismatches. These are some of the reasons why the actual result may be realized more slowly or on a smaller scale than our calculations would suggest. 

However, the overall implication is positive. Recognizing and addressing the problem is a good first step in the right direction. Even if the scale is small, policies are on the right track. The shift to focus on de-stocking and continued efforts to stabilize demand put China on a path towards tackling the big issues in the housing sector. Concurrently, it’s not a reversal to the old housing model meant to reinflate the bubble, but rather a pragmatic solution aligned with other development goals. If the current scheme goes as planned, there will likely be more follow-up actions or similar policies in the coming months.

THE SIZE OF CHINA’S TOTAL HOUSING INVENTORY REMAINS SIGNIFICANT

Residential inventory, million square meters

Source: Wind, J.P. Morgan Private Bank. Data as of April 2024.
The bar chart shows China’s residential inventory in million square meters from 2006 to April 2024, comprising 1. pre-sold, under construction, 2. unsold, under construction and 3. unsold, completed housing. In 2006, residential inventory was at a total of 1,515 million square meters, comprising of 376 million square meters in pre-sold, under construction housing and 1,139 million square meters in unsold, under construction housing. From 2006 to 2021, China’s total housing inventory has increased from 1,515 million square meters to an all-time high of 7,131 million square meters in 2021, with a consistent increase in pre-sold, under construction homes from 376 million square meters in 2006 to 3,908 million square meters in 2021. Unsold, under construction homes have also rose from 1,139 million square meters in 2006 to 2,996 million square meters while unsold, completed homes represent a small portion of total residential inventory from 2011 to 2021, around ~200-400 million square meters. From 2021 to April 2024, there has been a modest decline in total residential inventory from 7,131 million square meters in 2021 to 5,196 million square meters as of April 2024. Unsold, completed homes increased from 227 million square meters in 2021 to 391 million square meters as of April 2024 while pre-sold, under construction and unsold, under construction homes fell slightly from 3,908 and 2,996 million square meters in 2021 to 2,405 and 2,401 millions square meters as of April 2024. Despite the fall in residential inventory in recent years, the size of China’s total housing inventory remains significant, particularly pre-sold, under construction properties and unsold, under construction properties. When we use a broader concept of inventory that includes floor space under construction, we estimate PBoC’s RMB300bn special facility can only purchase at most 5% of this much broader stock of supply (unsold, completed properties). We therefore think it’s unlikely to result in an immediate turnaround of the property market.

None of these measures are likely to turn the housing market around immediately, and as such we don’t see any major upside risks to GDP growth in 2024. That said, if we see more policies in this style introduced in the coming months, we can see a modestly positive impact on growth for 2025 and beyond. 

There are two main transmission mechanisms. First is restoring a functioning credit and financial cycle. Local governments and financial institutions have been under pressure from housing deleveraging, evidenced by falling credit growth and declining fiscal revenues and spending. This is one of the negative housing spillovers that undermines the rest of the economy, particularly in new and growing sectors. Monetizing unsold housing inventory can help alleviate this problem; giving financial institutions and local governments more space to support other sectors and growth drivers.

Secondly, the three-year-long housing decline has dented business and household confidence. If policymakers are able to support housing while helping other growth drivers, it can bring about a stabilization in confidence.

LOCAL GOVERNMENT REVENUES HAVE FALLEN SIGNIFICANTLY DUE TO LOWER LAND SALES

RMB billions

Source: Wind, J.P. Morgan Private Bank. Data as of April 2024.
The bar chart shows China’s local government revenue and expenditure from 2018 to 2023, in RMB billions. China local government revenue was at 7,137 RMB billions in 2018 while local government expenditure was at 7,747 RMB billions. Local government revenue rose from 7,137 RMB billions in 2018 to 9,393 RMB billions in 2021 and local government expenditure increased from 7,747 RMB billions in 2018 to 11,528 RMB billions in 2020. However, a downward trend can be observed for local government revenue and expenditure from 2021 onwards. From 2021 to 2023, local government revenue fell from 9,393 RMB billions in 2021 to 6,628 RMB billions in 2023. Similarly, local government expenditure fell modestly from 11,528 RMB billions in 2020 to 9,648 RMB billions in 2023. Given that income from the sale of land-use rights is an important contributor to fiscal revenue for many local governments, the decline in land sales have caused local government revenues and subsequently, local government expenditures to fall significantly.

The U.S. announced new tariffs on US$18bn of Chinese goods, including EVs, batteries, semiconductors, steel & aluminum, critical minerals, solar cells, cranes, and medical products – while retaining Trump-era tariffs on more than US$300bn of goods. The tariffed goods represent only 4% of total Chinese exports to the U.S., and 0.5% of China’s total exports. Given their limited size, the new tariffs are unlikely to have a broad economic impact, but there will likely be sector-specific implications.  

In sectors that have a range of global suppliers and higher price sensitivity – like mature semiconductors, medical supplies and steel & aluminum products – trade with the U.S. would simply fall as those consumers source these products elsewhere. In sectors where there is a high level of China-dependency – such as batteries, battery parts and critical minerals – the U.S. could face higher prices until new supplies are developed. For sectors where bilateral trade is almost nonexistent – like EVs and solar cells – the tariffs are purely symbolic.

The new tariffs could reshape the U.S.-China battery trade and will likely raise costs for U.S. EV makers before they find reliable alternative sources. U.S. reliance on Chinese-produced batteries is a key reason why these particular tariffs will not phase in until 2026. Other countries with advanced battery industries such as Korea and Japan may gradually fill the gap in the U.S. market.

The U.S. is highly dependent on Chinese battery parts and critical minerals, with 24% and 59% imported from China respectively. China produces more than 65% of the world’s graphite, and increasingly sees exports of similar minerals from a strategic perspective. U.S. awareness of its reliance on China for critical minerals is evidenced by what is and isn’t tariffed. While new tariffs will be levied on more than two dozen raw materials, the U.S. was careful to avoid the critical minerals where China controls much global supply.

Retaliation, including tariffs on U.S. products, could soon follow, with reports that cars could be targeted. China’s room for policy responses on trade and investment is rather limited – after all, China exported more than US$500bn to the U.S. while importing only US$164bn; running a surplus of US$336bn in 2023. China’s trade with the U.S. is the most unbalanced across all of its trading partners.

CHINA HAS THE LARGEST VALUE-ADDED TRADE SURPLUS AGAINST THE U.S.

China value added trade balance, USD millions

Source: Organization for Economic Cooperation & Development, Haver Analytics, J.P. Morgan Private Bank. Data as of December 2020.
The bar chart shows China’s value-added trade balance, in USD millions with EU28, Vietnam, Thailand, Taiwan, Brazil, U.S., U.K., South Korea, Japan, Germany, France and Australia in 2020. Value added trade balance considers the value added by each country in the production of goods and services that are consumed worldwide. China runs a trade deficit with 9 countries/regions in 2020, namely the EU28 (USD 13.9bn), Vietnam (USD 9.2bn), Thailand (USD 579 mn), Taiwan (USD 64.7bn), Brazil (USD 31.4bn), South Korea (USD 47.4bn), Germany (USD 25.9bn), France (USD 2.8bn) and Australia (USD 58.4 bn). China runs a valued-added trade surplus with 3 countries, namely U.S. (USD 235bn), UK (USD 25.8bn) and Japan (USD 18.3bn). Amongst the 3 countries that China runs a trade surplus with, it has the largest value-added trade surplus against the U.S..
To emphasize China’s importance as a supplier, Beijing could begin restricting the trade of some critical minerals before the tariffs come into effect. In 2023, China already began restricting exports of gallium, germanium and high-grade graphite. But in other areas China has a dilemma: last year the country hinted that it wanted to prohibit exports of some advanced solar manufacturing technology, but didn’t ultimately proceed, likely because its firms want to continue exporting.

It’s unlikely we’ll see further escalation from the United States, at least until the election. Unlike in the past, the U.S. is not seeking to negotiate market access or use tariffs as a bargaining chip to encourage China to import more U.S. products. The measures are instead designed to protect specific industries, and thus the U.S. is unlikely to increase tariffs further unless they advance this objective. 

The key question is whether this U.S.-China trade war turns global. The EU has launched an anti-subsidy investigation into Chinese imports of wind turbines, solar panels, and EVs. There are reports that China is aiming to retaliate with tariffs on European auto exports. Unlike the U.S., Europe is a significant source of bilateral trade with China, leaving ample room for escalation and negative economic effects. The economics of the relationship point to a reasonable risk of escalation. As China attempts to generate future growth through investment in high-value manufacturing, Europe’s core logic for trade with China – importing attractive low-value-added goods and exporting high-value-added premium products – looks increasingly fraught, with European companies rapidly losing their edge to Chinese competitors, especially in autos. To prevent a “China shock” – widely viewed as a reason for the hollowing out of the U.S. industrial base – from impacting Europe, certain nations will likely join Washington in erecting new protectionist barriers.

In order to turn more positive on Chinese equities we have emphasized that we need to see a comprehensive property rescue plan and sustainably stronger domestic demand. The housing plan marks a significant step in the right direction and likely signals a change in policy direction. As a result, we expect market sentiment to improve somewhat, leading to a likely valuation re-rating. We slightly raise our index outlook to factor in some multiple expansion (end-2024/mid-2025 index outlooks are MSCI China at 67/69 and CSI 300 at 4,100/4,300), but keep our earnings estimates unchanged.

However, we still do not advise chasing this rally. The broader MSCI China has surged more than 30% from January lows, and we continue to recommend fading the bounce in offshore China as valuations no longer look distressed and the risk-reward is looking increasingly unfavorable. We see better value in the onshore market for long-term investors, alongside dividend names and structures for tactical investors.

On the currency, risks of increasing trade frictions is a key reason why we maintain a bearish bias on the outlook for the RMB. Uncertainty on the export outlook creates risks to the balance of payments and overall growth outlook, both of which weigh on the fair value for the currency. While determined intervention efforts has kept USDCNH relatively stable over the past year, lessons from the 2018-19 trade war suggest that authorities could turn more tolerant of currency depreciation so that the tariff impact is partially offset. While a sharp depreciation is not our base case, risk of further weakness from current levels over the next 6-12 months is high. 

TARIFFS IMPACTED CNH NEGATIVELY DURING THE TRADE WAR

Source: Bloomberg Finance L.P., J.P. Morgan Private Bank. Data as of April 2024.
The line chart plots the effective tariff rate on China exports to U.S. on the right axis and USDCNH on the left axis from January 2018 to May 2020. The effective tariff rate on China exports to U.S. started at 3.1% in January 2018 and increased slightly to 3.2% in March 2018. USDCNH started at 6.52 in January 2018 but fell slightly to 6.3 in February 2018. From February 2018 to March 2018, USDCNH was largely rangebound, fluctuating around ~6.3. From March 2018 to September 2018, the effective tariff rate on China exports to US increased from 3.2% to 12%, which resulted in a sharp depreciation of CNH as USDCNH increased from 6.3 in March 2018 to 6.8 in September 2018. From September 2018 to May 2019, the effective tariff rate on China exports to US remained constant at 12%. Even though there was a modest appreciation of CNH against USD, with USDCNH falling slightly from 6.8 in September 2018 to 6.7 in April 2019., there was no sharp increase or decline in USDCNH. In May 2019, there was a hike in U.S. tariffs on China exports, as the effective tariff rate on China exports to US rose from 12% in May 2019 to 17.3% in June 2019. USD appreciated against the CNH leading up to the tariff hike, with USDCNH increasing from 6.7 in April 2019 to 6.9 in May 2019. Following the rate hike, USDCNH stayed flat at ~6.8 from June 2019 to July 2019. At the same time, effective tariff rate on China exports to US remained constant at 17.3%. It was only until August 2019 that we saw a sharp depreciation of CNH against USD, as USDCNH increased from 6.8 in July 2019 to 7.2 in September 2019. CNH started depreciating against USD in early August 2019, leading up to the tariff rate hike in September 2019 which saw effective tariff rate on China exports to US increased from 17.3% to 21%. From September 2019 to May 2020, the effective tariff rate on China exports to US fell slightly from 21% to 19.3%, despite some fluctuations in between. During the same period, USDCNH, fell from 7.2 in September 2019 to 7.1 as of June 2020, suggesting a slight appreciation of CNH. Overall, an increase in the effective rate on China exports to US negatively impacts the CNH.

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Morgan SE – Stockholm Bankfilial, with registered office at Hamngatan 15, Stockholm, 11147, Sweden, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Stockholm Bankfilial is also supervised by Finansinspektionen (Swedish FSA); registered with Finansinspektionen as a branch of J.P. Morgan SE. In Belgium, this material is distributed by J.P. Morgan SE – Brussels Branch with registered office at 35 Boulevard du Régent, 1000, Brussels, Belgium, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB);  J.P. Morgan SE Brussels Branch is also supervised by the National Bank of Belgium (NBB) and the Financial Services and Markets Authority (FSMA) in Belgium; registered with the NBB under registration number 0715.622.844. In Greece, this material is distributed by J.P. Morgan SE – Athens Branch, with its registered office at 3 Haritos Street, Athens, 10675, Greece, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB); J.P. Morgan SE – Athens Branch is also supervised by Bank of Greece; registered with Bank of Greece as a branch of J.P. Morgan SE under code 124; Athens Chamber of Commerce Registered Number 158683760001; VAT Number 99676577. In France, this material is distributed by J.P. Morgan SE – Paris Branch, with its registered office at 14, Place Vendome 75001 Paris, France, authorized by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and jointly supervised by the BaFin, the German Central Bank (Deutsche Bundesbank) and the European Central Bank (ECB) under code 842 422 972; J.P. Morgan SE – Paris Branch is also supervised by the French banking authorities the Autorité de Contrôle Prudentiel et de Résolution (ACPR) and the Autorité des Marchés Financiers (AMF). In Switzerland, this material is distributed by J.P. Morgan (Suisse) SA, with registered address at rue du Rhône, 35, 1204, Geneva, Switzerland, which is authorised and supervised by the Swiss Financial Market Supervisory Authority (FINMA) as a bank and a securities dealer in Switzerland.

This communication is an advertisement for the purposes of the Markets in Financial Instruments Directive (MIFID II) and the Swiss Financial Services Act (FINSA). Investors should not subscribe for or purchase any financial instruments referred to in this advertisement except on the basis of information contained in any applicable legal documentation, which is or shall be made available in the relevant jurisdictions (as required).

In Hong Kong, this material is distributed by JPMCB, Hong Kong branch. JPMCB, Hong Kong branch is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission of Hong Kong. In Hong Kong, we will cease to use your personal data for our marketing purposes without charge if you so request. In Singapore, this material is distributed by JPMCB, Singapore branch. JPMCB, Singapore branch is regulated by the Monetary Authority of Singapore. Dealing and advisory services and discretionary investment management services are provided to you by JPMCB, Hong Kong/Singapore branch (as notified to you). Banking and custody services are provided to you by JPMCB Singapore Branch. The contents of this document have not been reviewed by any regulatory authority in Hong Kong, Singapore or any other jurisdictions. You are advised to exercise caution in relation to this document. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. For materials which constitute product advertisement under the Securities and Futures Act and the Financial Advisers Act, this advertisement has not been reviewed by the Monetary Authority of Singapore. JPMorgan Chase Bank, N.A., a national banking association chartered under the laws of the United States, and as a body corporate, its shareholder’s liability is limited.

With respect to countries in Latin America, the distribution of this material may be restricted in certain jurisdictions. We may offer and/or sell to you securities or other financial instruments which may not be registered under, and are not the subject of a public offering under, the securities or other financial regulatory laws of your home country. Such securities or instruments are offered and/or sold to you on a private basis only. Any communication by us to you regarding such securities or instruments, including without limitation the delivery of a prospectus, term sheet or other offering document, is not intended by us as an offer to sell or a solicitation of an offer to buy any securities or instruments in any jurisdiction in which such an offer or a solicitation is unlawful. Furthermore, such securities or instruments may be subject to certain regulatory and/or contractual restrictions on subsequent transfer by you, and you are solely responsible for ascertaining and complying with such restrictions. To the extent this content makes reference to a fund, the Fund may not be publicly offered in any Latin American country, without previous registration of such fund´s securities in compliance with the laws of the corresponding jurisdiction. 

References to “J.P. Morgan” are to JPM, its subsidiaries and affiliates worldwide. “J.P. Morgan Private Bank” is the brand name for the private banking business conducted by JPM. This material is intended for your personal use and should not be circulated to or used by any other person, or duplicated for non-personal use, without our permission. If you have any questions or no longer wish to receive these communications, please contact your J.P. Morgan team.

JPMorgan Chase Bank, N.A. (JPMCBNA) (ABN 43 074 112 011/AFS Licence No: 238367) is regulated by the Australian Securities and Investment Commission and the Australian Prudential Regulation Authority. Material provided by JPMCBNA in Australia is to “wholesale clients” only. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Corporations Act 2001 (Cth). Please inform us if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under US laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

This material has not been prepared specifically for Australian investors. It:

  • may contain references to dollar amounts which are not Australian dollars;
  • may contain financial information which is not prepared in accordance with Australian law or practices;
  • may not address risks associated with investment in foreign currency denominated investments; and
  • does not address Australian tax issues.

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INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

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