David Cui of Bank of America Merrill Lynch
Distortions in China’s housing market, along with other factors, may lead China into an extended period of asset deflation similar to Japan’s, according to a report released this week by Bank of America Merrill Lynch.
The report, “Will China Repeat Japan’s Experience?” was penned by analyst Naoki Kamiyama Head of Japan Equity Strategy in Japan, and David Cui, Head of China Equity Strategy for the US bank in Singapore. According to a report in Bloomberg, the pair note that, similar to Japan, China’s economy is characterised by “imbalanced growth, government stimulus, overcapacity, an overwrought housing market, and a severely under-capitalized financial system.”
Kamiyama and Cui predict that despite China’s 7.5 GDP growth last year, the country risks entering a deflationary period similar to Japan’s in the 1990s, when the country went through its famous “lost decade.”
China in 2014 Equal to Japan in 1992
Specifically, Kamiyama and Cui pin China in 2014 at 1992 on a Japan timeline, when that country’s long-growing real estate bubble began to deflate. The BoA Merrill Lynch duo contend that China’s current condition is even worse than Japan’s was at that time, saying “In general, it appears to us that the problem facing China today may be more serious than Japan’s in the late 1980s and early 1990s.”
During 2014 China’s real estate market has rapidly cooled down after an extended run of rising prices. According to China’s National Bureau of Statistics, the average price of housing in the country’s largest cities has slid downwards over the last three months consecutively. The dip in the housing market coincides with a slowdown in overall GDP, with growth struggling to hit the government’s 7.5 percent target for 2014 after years of stimulus-fed hypergrowth.
The Real Estate Market at a Tipping Point
Cui and Nakayama raised pointed concerns about dangers from China’s real estate sector, now that the government has moved to rein in the once-frothy market. The analysts assert that despite the relatively gentle tapering of real estate prices so far this year, that the property market is close to “tipping over.”
“We expect bad debt, reported and otherwise, to accumulate rapidly going forward (unless the government loosens monetary policy quickly),” Cui and Kamiyama wrote. The analysts predicted that that the non-performing loan ratio in China could be much higher than Japan’s at its worst.
On the best way to position portfolios during the asset-deflation phase, the report predicted Chinese banks in particular will suffer “significant downside” despite their poor recent performance, with developers and building materials also expected to start to “underperform significantly reasonably soon”, based on the experience in Japan.
JP Morgan Saw Similar Parallels
During July last year, JP Morgan produced a report that drew similar parallels between Japan and China. However, the report by the US investment bank also pointed out a number of differences between the economies of the two nations.
In particular, the JP Morgan report noted that China’s per capital GDP in 2014 is more similar to Japan in the mid-1970s than in the 1990s, that the 10% role of primary industry in China’s GDP is akin to Japan in the 1960s, and that China’s urbanization ratio is much lower now than Japan’s was in the 1990s.
Cui a Notable China Bear
Cui, who with his team was ranked first among Asia’s financial researchers in a poll by Institutional Investor magazine this year, has been notably bearish lately on China’s economic prospects.
In March when Chaori Solar became the first company to default on a commercial bond Cui wrote that, “We think the chain reaction will probably start. In the U.S., it took about a year to reach the Lehman stage when the market panicked … We assess that it may take less time in China.”
In comments during July on China’s equity markets he said that the 2014 rally in the Hang Seng China Enterprises Index (HSCEI) was driven by stimulus and predicted that the gauge market index would drop to 9600 by the end of the year. The HSCEI closed at 11,032.91 today, up from the 10,000 range in July.
Leave a Reply