The most recent US earnings announcements might catch the investment world’s attention this week, but one headline that did not seem to gain much press time was that made by the Chinese, with respect to their mortgage-backed securities market. The Chinese government agreed this week to allow banks to tap the debt market, by packaging up residential mortgages, a practice which had been banned in China since 2007.
The significance of this news should not, in my opinion, be understated and, given the strong rally that we have seen in the Chinese market all week, it would appear that those invested in the Chinese market have noticed it too. Despite strong HSBC PMI numbers this morning, property is one of the key laggards in the Chinese economy and if it continues to fall, GDP numbers of 7.5% are going to be hard for them to achieve. Nationwide, housing sales in China fell 9.2% in the first half of this year, while house prices in 70 cities slipped in June, for the second month, according to official data. New mortgages in Shanghai, China’s financial centre, declined 2.2% in the first half of 2014, according to a statement posted on the website of the Central Bank’s Shanghai head office last week. According to George Magnus, of UBS, property accounts for about 25% of capital investment, and roughly 13% of GDP. Incorporating associated industries, such as steel, cement, and construction machinery & materials, would raise the investment share of GDP to about 16%. So, in other words, the property market is fairly crucial to the Chinese government’s “promise“ to achieve growth in excess of 7%. This latest move to allow banks to bolster their balances sheets, by freeing up liquidity, is decidedly positive in the short term and allows banks to increase their lending. (Note: This commentary is too short to go into the moral hazard of protecting a property market bubble.)
The Postal Savings Bank of China said on Wednesday that it encountered a healthy demand for an offering of 6.8 billion Yuan (1.1 billion US Dollars) of mortgage-backed securities. The issue was 1.25 times subscribed. Many would think this is a risky investment and I am not advocating subscribing to these issues in a declining property market, but it should be noted that mortgages are relatively safe in China, given that first-time home buyers have to put down a 30% deposit. The world wants China to balance its economy more towards the domestic economy and by trying to support the housing market, it is doing exactly that. This should also help alleviate concerns over a sudden slowdown in the Chinese economy and thereby soften one of the “black swan” events in world markets. The Chinese market has been an underperformer for a number of years now and, unlike other markets, has not reached all-time highs. Rhetoric towards EM equities has turned more bullish of late and in fact, over the last couple of months, EM equities have outperformed DM equities. Is this now China’s turn to do the same? On a PE of 10, it is looking decidedly attractive (refer to the long-term graph above).