07 December 2023
Enodo Insight
Equity Market Blues as China's Soaring Debt Evokes Bubble-era Japan
- China's ratio of credit to GDP for the non-government non-financial sector is above bubble-era Japan and Korea
- Credit losses could reach between 37% and 42% of GDP after China's borrowing binge
- Equity market depressed as domestic investors save and foreigners stay wary
- We are bearish on Chinese A-shares until the “national team” starts to buy
Debt-deflation plagues China’s economy
Credit to the private non-financial sector
% of GDP, latest data Q1 2023
Source: Enodo Economics, CEIC, BIS
- The ratio of credit to GDP for the non-government non-financial sector in China has now risen well above the peak in Japan and Korea during their respective debt bubbles
- China is in uncharted territory. Korea has recently caught up with China but that spells trouble for Korea rather than giving comfort to China
Credit by sector
% of GDP
Source: Enodo Economics, CEIC, BIS
- The ratios of non-financial debt and that of non-government non-financial debt to GDP are higher in China now than in the majors during the Great Financial Crisis (bar Japan for financial debt)
- China now also has less fiscal room for maneuver than the US and the UK did during the GFC. It is on par with the Euro area and less constrained than Japan was
Credit losses loom large amid deflation
China's estimated credit losses
% of GDP
Source: Enodo Economics, CEIC Data; Wind
- Enodo has combined bottom-up analysis of China’s quoted sector loans with a top-down macro evaluation of the returns on credit, to estimate expected loan losses following its post-GFC borrowing binge
- We estimate credit losses at a staggering range of between 37% and 42% of GDP
Inflation measured by CPI and the GDP deflator
Yoy
Source: Enodo Economics, CEIC
- China is in deflation. The official GDP deflator fell in both Q2 and Q3 by an average of 1.5%
- There have been only three times when the deflator was in negative territory for 2 consecutive quarters - during the Asian Financial Crisis, the GFC, and 2015-16
- We expect underlying deflationary pressures to persist although base effects can help push CPI into mildly positive territory
Downbeat “animal spirits”
Mortgage borrowing growth
Residential housing
Source: Enodo Economics, CEIC
- Annual mortgage borrowing growth has fallen off a cliff. It started declining in Q1 2023 amid falling house prices
- Authorities have been trying to boost mortgage demand by ordering banks to lower mortgage rates and increase loan-to-value ratios, as well as providing other administrative incentives, but so far to no avai
Urban depositor confidence survey: saving and investment
Source: Enodo Economics, CEIC
- The housing market downturn and downbeat employment expectations have been weighing on consumers who have chosen instead to boost their bank deposit holdings
- The increased desire to hold liquid money balances has depressed equity prices despite decent broad and narrow money growth
Continued risk aversion bodes ill for equities…
Equities and money growth
Source: Enodo Economics, CEIC
- Narrow and broad money growth have slowed down in recent months. Increased risk aversion continues to lead to higher demand for holding money balances
- China’s “national team” will need to boost its equity holdings or the mooted equity stabilisation fund must spring to life in order to boost prices and potentially unlock some pent-up liquidity
Net inflows via Northbound Connect since inception
Rmb bn, daily
Source: Enodo Economics, Wind
- Net northbound inflows have been falling in recent months
- Foreign investor confidence in A-shares remains weak and is unlikely to kick-start an upturn
…as do falling industrial profits…
Industrial pre-tax profit
Qoq ar, sa & yoy
Source: Enodo Economics, CEIC
- Industrial profits rose in Q3 but only mildly, so the four-quarter average of year-on-year growth remains in negative territory
- We do not expect a strong recovery in profits nor an improvement in margins as firms lack pricing power
Liability to asset ratio by type of firm
Source: Enodo Economics, CEIC
- The liability-to-asset ratio at private firms has risen significantly in recent years and now surpasses that of SoEs
- SoEs poised to outperform private firms amid continued regulatory pressure to raise dividends and share buybacks
…despite attractive valuations
P/E ratio
Shanghai A-shares, daily
Source: Enodo Economics, CEIC
- Valuations remain depressed and could worsen further unless there’s a sustainable boost to GDP growth
- The Party has yet to convene its Third Plenum session which is typically dedicated to the economy, so more fundamental changes may be afoot
- But the challenges policymakers face in China today are daunting
CSI 300 vs SSE dividend index
Daily
Source: Enodo Economics, Wind
- Beijing continues to encourage companies to pay out dividends
Beijing is worried about capital leaving China
Capital flows
$ bn, 4-quarter sum for capital flows
Source: Enodo Economics, CEIC
- Capital outflows are a serious worry for Beijing
- Beijing is likely to defend the yuan but we have started to worry that they could begin a stealth tightening of capital controls on foreign direct investment
- Beijing’s decisive lurch into “one-man rule” and deteriorating Sino-US relations have reinforced Western investors’ perception that long-term investing in China is imprudent in the context of the Great Decoupling
A-share performance
Daily rate
Source: Enodo Economics, Wind
- We remain bearish on Chinese A-shares for now until we see more sustained buying from the “national team”
- Nonetheless, all is not doom and gloom. If America lurches into recession next year, Chinese A-shares could outperform US equities in relative terms