Stock vs. Property

The last time Mainland shares plummeted from such dizzying heights property prices followed suit, but this time around we could be headed for a different result

The world watched on in horror this summer as a whopping US$3 trillion in Chinese wealth disappeared within the space of a month thanks to the meltdown of the Mainland stock market. Pundits were quick to reassure investors and worried onlookers that this was not the end of the world, but simply a correction. Despite a onethird drop in the market capitalization of the country’s two main exchanges in Shanghai and Shenzen, the underlying economy of China was still safe and sound, the analysts remarked.

After all, the midsummer meltdown was preceded by a year-long bull run which gathered so much pace towards the later part of 2014 that China’s stock market rose to become the second most valuable in the world, tipping the scale at US$4.5 trillion at the peak. When the market continued its surge in the new year, many economists warned of a bubble on the verge of bursting. Share prices had moved far out of step with earnings in a slowing economy, and this signalled problems on the horizon.

The freefall began on June 12th and the worst of the bloodletting was over by mid-July. Regulators used just about every trick in the book to halt the volatility, and world opinion questioned the free nature of the stock market. The financial impact seemed to be contained to a certain degree and even the International Monetary Fund issued statements dispelling fears of wider contagion. Still, commodity markets took note and adjusted for potential risk, causing oil prices to shudder as analysts predicted a further economic slowdown.

Property Fallout?

In late July, as investors counted their losses, several media reports emerged suggesting the meltdown may have an impact on China’s all-important property sector. One article in particular, entitled “Investors flock to sell properties, cancel contracts” published by the Nikkei Asian Review, carried anecdotal reports of investors pulling money out of housing to cover equities losses and property prices easing due to a shortage of buyers. The report went on to state that “continued turmoil on the stock market looks as though it will have a major impact on the country’s real estate market.”

The financial analysts pointed out that any issue on the real estate front would not be good news for the economy. Economist Tim Condon of ING Group predicted that China needed the recent rebound in the housing market to continue if Beijing was to hit its 7% economic growth target for 2015. At that point, it sounded like the stock meltdown may have had more far-reaching consequences than initially thought. But, is there really a strong correlation between equity prices and the property market in China? Well, a look back at the not-too-distant past may be cause for concern.

Shares vs. Property

On 27 February 2007, the Shanghai Composite index plunged by more than 9%, wiping out hundreds of millions of dollars in market value. Investors turned bearish and, at one point in 2008, the Mainland stock market had fallen to 40% of its original high point. The crash coincided with a fall in home prices, leading many investors to fear that a collapse in stock prices could wreak havoc on property values.

Shortly after, academics Yikun Huang and Xin Ge published a report looking at the correlation. “House prices and the collapse of the stock market in Mainland China: An empirical study on the house price index” found that at face value, property prices fell in-line with stock prices with a lag of around three months. However, the study ultimately concluded there was a weak correlation between stock market movement and property prices.

That was then, and this now. Could China’s stock market correction, coupled with an oversupply of real estate and the country’s lowest economic growth rate in a quarter of a century combine to push house prices down?

Joe Zhou, head of research at property services firm Jones Lang LaSalle, believes there’s nothing to worry about. Stories of property price discounts after the most recent stock meltdown were “very anecdotal” and accounted for a “very tiny percentage” of the market, Zhou remarks. Some estimates put households with a stake in equities at just one in 30.

“In my view, the stock turbulence is probably better for the property market,” Zhou added. “More investors are realizing the risks of the stock market and property prices have grown steadily. It seems now, particularly in tier one cities, the price is picking up quickly and that will drive more home buyers to enter the property market.”

Describing the Shanghai property market in particular as “still pretty hot”, Zhou believes that demand is diverse. The property market strength is more than just migrants driving prices up, it is existing home buyers looking to upgrade. Overall, China’s real estate market has shown signs of a rebound after weak demand and a glut of new homes triggered a slowdown in 2014, which continued into early 2015.

A survey by the China Index Academy showed the market picking up, with new home prices rising for three consecutive months to July. The average price per square meter in a sample of 100 cities across China increased 0.54% month-onmonth to US$1,747 in July.

Julian Evans-Pritchard, a China economist at Capital Economics, agrees that the stock meltdown will not have too much of an impact on the property market. Although Evans-Pritchard heard reports of people being forced to sell property holdings to cover margin positions and losses made on stocks, he maintains the relationship between the rival investment classes has not been strong over the longer term.

“I do think that the case in 2007-2008 is interesting as the two investment sectors did move together fairly closely, with a bit of a lag,” Evans-Pritchard says. “But, if you plot the changes in property prices and changes in equity prices in China over a longer horizon – the last decade or so – the relationship hasn’t been that strong.” Between 2010 and 2014 stocks basically went nowhere and were down year-on year for most of that period, yet property prices continued to climb. Economists point to one major difference in the broader economy between the 2007- 2008 period and this year’s meltdown to explain why property prices will remain largely immune to the collapse in equities: interest rates.

Monetary Easing

When the property market fell in 2007- 2008, China’s central bank had started to tighten monetary policy as the economy was overheating and inflation picked up. Interest rates were rising and, as a result, mortgage rates climbed as well.

Evans-Pritchard notes that the downward pressure on interest rates “probably played a big role in pushing down property prices in 2007. It’s just that the falling stock prices and tight monetary policy happened to coincide. The big difference this time round is that the People’s Bank of China is not expected to raise interest rates anytime soon. At this stage, that is one reason that the fall in equity prices will not cause a collapse in property prices.”

In other words, it seems that policies put in place to weather the gradual economic slowdown hitting the Chinese economy may have insulated households, and the property sector, from any potential damage caused by the stock market storm. However, whether this can be sustained in the long-term is an issue.

Broader Impact

It is not just lower interest rates that give economists confidence about the growth of the broader economy in the second half of the year. The government’s promise to speed up fiscal spending and plough money into stocks through government controlled fund managers should have a positive effect. And, crucially, with respect to the stock market meltdown, the absence of the so-called wealth effect will play a role.

In developed countries a sharp rise or fall in the value of equities leads to a corresponding change in consumer spending. However, in China, spending tends to remain constant despite large fluctuations in the stock market. Capital Economics believes that the evidence suggests households save a fixed portion of income and split these savings between different investment classes, regardless of whether stocks or deposits go up or down. Although there’s significant volatility in the market, the number of households affected is not that big, and the effect on those impacted will not spread to other areas. And, if this is the case, then property owners can rest assured that property prices will not plummet, despite the immense pressures placed on the system with a stock market meltdown.

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