While Credit Growth Continues To "Collapse", China Is Again Building Apartments "To The Heavens"

Submitted by Gordon Johnson of Vertical Group

While many have attributed the resilience in China’s steel prices this year to Xi Jinping’s “supply-side reform magic”, we believe a much more basic measure is at play. More specifically, we believe that as external pressures began growing last year, intensifying earlier this year (i.e., an escalating global trade war + US dollar appreciation + resumption of hot money outflows [Ex. 5]), China resorted to its old ways and unleashed its property market… yet again.

Consequently, given China’s property market is, by far, the most highly steel intensive segment of its economy (accounting for just over 53% of Chinese steel produced in 2017; the next biggest consumer of steel in China was the Machinery segment at just 15% of steel consumption – Ex. 6) it is no surprise that steel prices in China, and thus the world, have bucked the broad-based trend of falling bulk metals prices in 2018.    

Exhibit 1: China Total Credit Growth versus Bank Asset Growth, %Y/Y

Source: Peoples' Bank of China (PBOC), Vertical Group.

Exhibit 2: China Fixed Asset Investment, Y/Y% (Infrastructure Collapsing)

Source: National Bureau of Statistics of China, Vertical Group.

Exhibit 3: Growth Internals - China (FAI, Industrial Production, & Retail Sales)

Source: National Bureau of Statistics, Vertical Group.

Exhibit 4: China Export Growth – Freight Volumes versus Values, %Y/Y

Source: National Bureau of Statistics, Vertical Group.

Exhibit 5: China Hot Money Flows

Source: Bloomberg, Vertical Group.

Exhibit 6: China Steel Consumption by Segment

Source: National Bureau of Statistics, General Customs Administration, Bloomberg, Mysteel, World Steel Association, Vertical Group.

HOME PRICES IN CHINA REBOUND STRONGLY: As detailed in Ex. 7 below, June new home prices in China accelerated for the fourth straight month to an impressive +1% m/m.

Exhibit 7: Average Price Change of New Residential Buildings, by Tiered-Cities, %M/M

Source: National Bureau of Statistics (NBS), Vertical Group.

Furthermore, when looking at y/y data it’s clear that while demand in Tier 1 cities remains in check, second/third-and-fourth-Tier cities, or ~90% of the Chinese housing market, are seeing increasingly bullish pricing trends (Ex. 8).

Exhibit 8: Average Price Change of New Residential Buildings, by Tiered-Cities, %Y/Y

Source: National Bureau of Statistics (NBS), Vertical Group.

And, the number of cities with rising home prices on a m/m basis ballooned to 63 in June, a high not seen since Sep. 2016 (Ex. 9).

Exhibit 9: New Home Prices 70-Cities M/M: Number of Cities Up vs. Down

Source: National Bureau of Statistics (NBS), Vertical Group.

As would be expected (Ex. 10), the follow-through to construction volumes was immediate – June construction starts were, admittedly, impressive with a  second month in a row posting all-time highs for floor area started (i.e., residential + commercial + office). In fact, YTD, floor area starts are now up +11.8% YTD, vs. +10.8% YTD as of May 2018, and just +7.3% YTD as of April 2018.

Exhibit 10: China YTD Construction Starts (Resi + Commercial + Office)

Source: National Bureau of Statistics (NBS), Vertical Group.

This has been enough to push YTD floor space under construction up to +2.5% for June, from +2.0% YTD in May 2018 (Ex. 11).

Exhibit 11: China YTD Area Under Construction (Resi + Commercial + Office)

Source: National Bureau of Statistics (NBS), Vertical Group.

In turn, this has been a major driver of still “insane” Chinese steel output – which, as displayed in Ex. 12 below, fell back to 80.2mmt in June, albeit still a record monthly high (implying faith in Xi Jinping’s widely touted supply-side reform may be misplaced).

Exhibit 12: China's Domestic Monthly Steel Production

Source: National Bureau of Statistics, Vertical Group.

Yet, when looking at cement production (Ex. 13), which fell hard in June (down -7.0% m/m, after rising just +2.1% m/m in May, following April’s +36.5% rise), it’s clear that investment in China’s domestic infrastructure build-out continues to suffer – unlike steel, which can be exported for One-Belt-One-Road (“OBOR”) based international projects, Chinese cement does not have huge export demand.

Exhibit 13: China YTD Cement Production

Source: National Bureau of Statistics, Vertical Group.


Taken together, these are indeed crazy numbers (i.e., something for both the bulls and bears) – a number of stimulus components are cooling fast, while construction components are indeed heating up (admittedly, a bullish indicator for steel prices in China, and we believe why they’ve been so strong in the face of broader bulk commodity price pressures).

However, we do not feel the current level of real estate investment in China is sustainable, and note June typically marks the peak (Ex. 10). What backs our views here? In short, China has been tightening not loosening more recently (the PBoC has withdrawn a record ¥1,230bn in liquidity from the market in 2018), and yuan outflows (which we’re seeing now – Ex. 5), which have just recently picked up steam, have historically hit realty in China especially hard. Yet, with property prices in sub-tier one cities rising again, sparking an immediate response in supply, we admit that we likely need to see prices cool before new starts momentum begins to slow considerably (while June’s +15.0% y/y growth in new starts was strong, it was below May’s +20.5% y/y growth rate).

Furthermore, with mortgage credit still on the decline (Ex. 14) – China’s June 2018 home loan growth of +18.8% y/y is the lowest seen since April 2016 when China was in the later innings of a steel demand shock that sent prices tumbling lowerwe believe the base case still remains growth slowing through 2H18 as weaker credit in the housing market ebbs both prices and starts later this year.   

Exhibit 14: Household Loans, Y/Y%

Source: PBoC, Vertical Group.

Additionally, while we acknowledge that China’s housing starts have indeed been robust (likely due to the government’s desire to develop a rental housing sector), there are two major warning signs flashing red – implying new start growth will imminently begin to moderate.

What do we mean? Well, as detailed in the Exhibit below, signs of weakening land purchases, which lead housing starts, are now showing clearly.

Exhibit 18: China Residential Real Estate Activity, Y/Y%, 6mma

Note: January is omitted from rolling figures as NBS does not release official January data.
Source: National Bureau of Statistics, Vertical Group.

Additionally, when looking at property transaction sales in China, it would seem that a significant slowdown in housing starts is imminent. In fact, based on the numbers below, it would appear that property starts in China will slow to sub-8% growth for the full year (vs. +11.8% YTD y/y growth currently) and fall further in 2019 (i.e., likely ~5% y/y growth). At risk of stating the obvious (with infrastructure FAI collapsing) this does not paint a bright picture for global steel prices over the near-to-intermediate term. Caveat emptor.

Exhibit 2: Housing Starts "Appear" to be Strong, But Property Transaction Data Suggest this will be Short Lived

Note: January is omitted from rolling figures as NBS does not release official January data.
Source: National Bureau of Statistics, Vertical Group.

* * *

CONCLUSION: With infrastructure investment waning, and home price growth accelerating, a lot of pundits are denoting more aggressive stimulus from China on the way.

However, when considering first tier cities are in a slow melt while lower tiers are growing at sustainable levels, as we see it, from the PBoC’s perspective, there’s really likely no real reason to shift policy either way yet; and if it comes, adjustment will much more likely be the removal of local lending restrictions than interest rate cuts.

Among the key signals we’ll see when this beings in China, using history as a barometer, will be deficit spending, especially on infrastructure. In fact, you’ll see lots of announcements from the National Development and Reform Commission (“NDRC”) and spikes in credit drivers… not in bank or shadow-bank lending, but the bond markets. So how are the bond markets fairing? Well, China government bond issuance saw growth slow to +20.2% y/y in June vs. +20.8% y/y in May (and +23.0% y/y in April), and China corporate bond issuance fell from -4.8% y/y in May to -5.4% y/y in June (and -3.9% y/y in April).

Exhibit 15: Chinese Bond Issuance, Y/Y%

Source: ChinaBond, Bloomberg.

OTHER INDICATORS: In a sign that the global construction boom (which we have contended for some time has been anchored by China’s infrastructure push – Ex. 16) may be nearing its end, construction vehicle sales in China cooled considerably in June – June y/y excavator sales growth of +58.8% was down sharply from the March, April, and May rates of +78.9%, +84.5%, and +71.4%, respectively. Additionally, turning to industrial output volumes (Ex. 17), with cement lagging (again, indicating cooling infrastructure investment in China) and non-ferrous metals lagging, against a backdrop of still strong crude steel output, it would seem to reason that steel prices in China, based solely on this data, could indeed be at risk.

Exhibit 16: China Construction Vehicle Sales, Y/Y%

Source: Hong Kong Teng Yuan Co. Ltd., Vertical Group.

Exhibit 17: Industrial Output Volumes, Y/Y% (cement lagging + non-ferrous metals lagging + steel leading = potential for steel price correction)