China's Housing Bubble Bursts: Evergrande Cuts Earnings Guidance By 50%

Now that the world is firmly focusing on apocalyptic forecasts about the state of the US and global economy, with St Louis Fed president James Bullard the latest to pour gasoline into the fire with his worst-case prediction of a 50% GDP drop and 30% surge in unemployment in Q2, it is easy to forget that China, which started this whole pandemic, is still in economic lockdown. And while Beijing is pretending that the Shanghai Sniffles are now firmly behind it, and forcing people back to work while openly fabricating disease numbers  - because like Lloyd Blankfein it has realized that an economic depression is an even worse outcome than millions infected - the reality is that China's economy is facing an unprecedented crisis of its own.

Today we got a stark reminder of that, when Evergrande Group - China's second-largest property developer by sales - tumbled in early trading Monday after saying it expects full-year earnings to fall by half.

As Bloomberg first reported, the residential property developer said in an exchange filing Sunday that net profit for 2019 is expected to come in it around 33.5 billion yuan ($4.7 billion), a drop of about 50% from the previous year.

"The decrease in profit is mainly attributable to the delivery and settlement of the lower-priced clearance stock properties in 2019, which drove down the unit price of the property delivered," Evergrande said.

That sent the firm’s Hong Kong-traded shares down as much as 17.4% on Monday, the biggest intraday drop since July 2015. And with the stock tumbling by more than two-thirds since its late 2017 highs, Citigroup downgraded the stock to "sell" and slashed its price target by 56%, as the expected decline in core profit was far below Citigroup’s estimate of a 27% year-on-year drop.

To be sure, there are plenty of reasons to dump the stock: Evergrande is one of China’s most-indebted developers with net debt of $88.5 billion as of June. As Bloomberg reminds us, the company has been pouring billions of dollars into acquisitions as its Chairman and major shareholder Hui Ka Yan pursues an ambition to make Evergrande the world’s biggest maker of electric cars in the next three to five years.

Yet while Evergrande did everything in its power to offset the current demand plunge, embarking on an aggressive marketing campaign as the coronavirus outbreak deepened, offering discounts of up to 25% on many of its projects, get-out clauses for buyers and price-match promises, its guidance indicates that the housing bubble in China has finally burst despite laughable government official data which saw an actual increase in average housing prices in February when the economy cratered.

The recent price cuts followed a surprise move all the way back in March 2019, when with the economy supposedly humming, Evergrande announced it first (of many) price cuts, offering properties at a 10% discount. It's only been downhill from there.

In some ways, Evergrande's liquidation campaign worked out: the firm’s contracted sales for Feburary jumped 108%, however this was achieved with firesale prices, and now that the entire Chinese house of cards is, literally, shaking it is only a matter of time before the ongoing economic malaise tears it to the ground.

This ia problem because as we said back in 2017, the "fate of the world economy is in the hands of China's housing bubble", and explained that for the Chinese population, and growing middle class, to keep spending vibrant and borrowing elevated, it had to feel comfortable and confident that its wealth would keep rising.

However, unlike the US where the stock market is the ultimate barometer of the confidence boosting "wealth effect", in China it has always been about housing as three quarters of Chinese household assets are parked in real estate, compared to only 28% in the US, with the remainder invested in financial assets.

Source: Xinhua

 

Beijing knows this, of course, which is why China consistently reflates its housing bubble any time it feels the broader economy is slowing, hoping that any subsequent popping of the bubble, which happened in late 2011 and again in 2014, will be a controlled, "smooth landing" process.

Alas this time it appears to have failed, because while Beijing has been scrambling to indicate that it has again succeeded in maintaining price stability - per Beijing's massively doctored official data - allowing the air out of the "Tier 1" home price bubble which peaked in early 2016, while preserving modest home price appreciation in secondary markets, the Evergrande profit cut clearly indicates that China's housing market is now facing nothing short of a hard landing.

One final though: back in the global financial crisis of 2008 it wasn't the US fiscal stimulus, nor was it even the Fed's QE that sparked the global recovery that pulled the developed world out of a depression: it was China, which turned on the debt afterburners and issued trillions and trillions in new money, eventually reaching the absurd point in 2017 when China accounted for half of all global debt created since 2005.

Needless to say, much of this credit spree was contingent on continued stability in China's housing market. However, now that that is gone, and with Chinese debt to GDP around 300%, or an all-time high, one can forget any hope for a massive Chinese credit-fueled recovery similar to what happened in 2008. In fact, if China's housing bubble has indeed burst, and for validation of this keep a close eye on what Evergrande will say in the coming weeks, what the world should expect is a reversal of China's epic debt firehose, which unfortunately means that just as China managed to pull the world out of its 2008 depression, payback time has arrived and this time it is China that will ensure that the depression of 2020 is truly one for the ages.