Is China's market value underestimated?

Is China's market value underestimated?

The US-China rivalry continues to dominate headlines, with America seeking to confront China's economic practices, such as predatory industrial policy and intellectual property theft. Meanwhile, China is grappling with its own economic challenges, most notably the collapse of its real estate sector.

The crisis, centred around the $50 billion Evergrande collapse and widespread defaults on property bonds, has exposed systemic risks in China's overleveraged real estate market. Once accounting for about 25% of GDP and constituting approximately 50% of Chinese household wealth, the sector's decline has led to significant economic consequences.

The property sector's decline has caused substantial wealth erosion for households, undermining their financial security and dampening consumer spending. Troubled households are forced to sell properties, affecting confidence and consumption levels negatively. This wealth effect and rising unemployment in manufacturing due to cost pressures have further weighed on domestic demand and consumption sentiment.

Beijing has implemented strict regulatory measures, such as the "three red lines" policy, that have accelerated defaults but aimed to reduce leverage and stabilize the sector. Despite attempts to revive the market over recent years, including targeted support for affordable housing and promoting sustainable development, the sector's woes persist. Authorities also face the challenge of managing unfinished housing projects and creditor claims without precipitating a broader economic collapse.

The government seeks to balance short-term stability with a long-term economic reorientation away from the overreliance on real estate towards industrial innovation and technology-focused growth. The slowdown in real estate is dragging down overall GDP growth by about 25% linked to the sector. It has also introduced systemic risks to debt chains and global commodity markets due to China’s economic slowdown, creating ripple effects worldwide.

Meanwhile, industrial production growth and export demand are impacted by tariffs and global trade tensions, compounding pressures on the labor market and domestic consumption. However, the decline of real estate's macroeconomic dominance creates a pivot toward new sectors such as industrial development and technological innovation for investors.

China's structural economic shifts emphasize diversification away from real estate, focusing on affordable housing, tech, and industrial policies that support self-sufficiency. Investors are advised to geographically diversify, hedge commodity price risks, and closely monitor policy changes as the country seeks a more sustainable and innovation-driven growth model.

The housing bust has affected Chinese consumers' confidence, which is currently at near-record low levels. Retail sales growth in China was only 2.2% in July, far below the 10% historically achieved. Stock prices, especially for property shares, are on a downtrend and have fallen over 40% in four years. New home prices in China have fallen by 5% year on year, marking the 13th month of consecutive declines.

Despite the challenges, some investment strategies view China's struggles as an opportunity. Invesco Asia Trust, for instance, takes a contrarian view, being overweight China. Performance in the last year for Invesco Asia has been flat, but it has returned a respectable 36% over five years. The trust has £240 million of net assets and trades at an 11% discount to net asset value (NAV) and yields 4.3%.

However, not all investment strategies are bullish on China. Schroder Asian Total Return trust is "significantly underweight" with an allocation of 15% to China (including Hong Kong) compared with 33% in its benchmark index.

Geopolitical tensions, particularly between America and China, are likely to continue. China appears to prefer bullying and threatening Taiwan rather than the risk of an actual invasion. The Chinese population is ageing rapidly, reducing demand and construction activity. Ten-year government bond yields in China have plunged to 2.2%.

According to investment strategist Ed Yardeni, China's real-estate collapse could lead to a deflationary economic bust. He also predicts that Chinese nominal GDP growth could turn negative over the next six months.

In conclusion, China's real estate collapse has deeply eroded household wealth, subdued consumption, forced a tough government balancing act, and is catalyzing a strategic shift in economic structure and investment focus towards industry and innovation while managing ongoing systemic risks.

1. The erosion of household wealth due to the decline of China's real estate sector has led to a significant decrease in consumer spending.
2. The government's regulatory measures, such as the "three red lines" policy, have aimed to reduce leverage and stabilize the property market, but the sector's woes persist.
3. Investors are advised to geographically diversify, hedge commodity price risks, and closely monitor policy changes as China seeks a more sustainable and innovation-driven growth model.
4. Schroder Asian Total Return trust is "significantly underweight" China, with an allocation of 15% to China (including Hong Kong) compared with 33% in its benchmark index.
5. According to investment strategist Ed Yardeni, China's real-estate collapse could lead to a deflationary economic bust and Chinese nominal GDP growth could turn negative over the next six months.

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