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News Release


[Commentary] China’s stock market and implications for commercial property

Steven McCord, Head of Research at JLL in North China


Key takeaways:

  • The Chinese stock market crash does not tell us much about the real economy in China
  • The global sell-off was not triggered by economic indicators
  • The Chinese yuan devaluation caused confusion, but was part of ongoing structural reform
  • The recent interest rate and reserve requirement ratio cuts will provide a meaningful economic boost
  • Direct effects on property are relatively few

    Does the stock market tell us anything about the Chinese economy?

    In the past week, China's domestic stock market has resumed a steep decline and caused widespread concern about the health of China's economy. However, a crash in Chinese stocks does not tell us much about the real economic conditions in China. The limited amount of institutional investment and the absence of international investment mean that the market does not get the level of analytical treatment that other markets might. The market is largely driven by individuals rather than professional investors, and individuals are highly sentimental. Furthermore, the average company in China does not depend on the local stock market for financing. We can see that the total size of the stock market is still small relative to the size of the economy. In addition, the government holds two-thirds of market capitalisation, which is not openly traded on the market. Therefore, only a small portion of company shares are traded on the market. Furthermore, the average individual does not depend on the market as an investment tool. In fact, only between 7% and 15% of household wealth is in stocks, compared to 60% in the USA and 29% in Japan. Most wealth is in bank deposits and property. Additionally, two-thirds of stock brokerage accounts have less than USD 15,000 on deposit. We have observed that the market was relatively flat for over five years between 2009 and 2014 and was not responsive to either external or internal events, including the spectacular economic growth of 2011, or the EU crisis. The market was dormant until suddenly, in late 2014, a bubble was inflated.

    Why was a bubble inflated?

    Many will question why a bubble was inflated. First, it was a way to boost public confidence and draw attention away from economic debates. It was desirable to increase equity financing opportunities for companies. The Stock Connect scheme and interest rate cuts laid a solid foundation, but a speculative component quickly took over. Safely insulated from the rest of the world, a rally was seen as a desirable wealth creation tool given the limited investment channels available to individuals in China and weakness in the residential market in Tier II and Tier III cities. However, it did not take long for P/E ratios to become unrealistically high, showing that they were not based on profit, but on the weight of capital bidding up prices. Individuals invested with confidence in the belief that the bull market had the backing of government and would backstop any losses. However, when official efforts to rein in margin financing occurred, this raised concerns that the government was shedding its encouraging stance. When investors started to question the level of government support behind the market, they sold.

    Why was there a global sell-off?

    Global markets did not react to the China stock market crash in June. Why did they react this past week in August? Are foreign stock markets reacting to poor Chinese economic data? We believe the answer is no. There have been no significant economic data announcements recently, other than the export drop, which by itself is not unusual or particularly new. In fact, economic data is mixed, just as it has been for quite some time. While a weak Purchasing Managers Index number is a valid concern, manufacturing is not considered a major focus for economic growth. In addition, lower oil prices are a positive factor for China's growth, not a negative one. Overseas equity investors saw a market going down in China, and a knee-jerk reaction took place, leading to sell-offs. The summer holiday season also meant that many senior decision-makers were probably not available to question the relationship between the Chinese stock market and the real economy.

    The RMB devaluation: misunderstood

    An important catalyst in the global sell-off was that the devaluation of the yuan was widely misunderstood. There was poor messaging behind the central bank's goals that led to mixed signals and much confusion. Overseas markets saw it as something it was not – they assumed it was devalued solely due to poor economic performance. In fact, the devaluation was not linked to any specific economic news. It was part of an ongoing exchange rate liberalisation as China slowly moves away from a fixed rate regime one step at a time. It is a structural reform that should be done one way or another. The timing may not have been optimal for exchange rate reform, but it was pushed through since a window of opportunity opened up at that time. The political commitment was in place to make it happen swiftly, since a more market-driven exchange rate is needed in order for the yuan to become a global reserve currency.

    Overseas stock investors also saw a failure to contain the domestic stock slide. While significant efforts were made that worked for a time, there was disappointment when the government allowed the slide to resume. We note that there are other precedents globally, and parallels were being made to the price-keeping operations of Japan in the 1990s, which ultimately failed.

    What's next?

    The result is that the Chinese stock market is on the path to returning to where it was during 2009-2014 as the bubble bursts. This in and of itself is not meaningful. The recent cuts to the benchmark interest rate and the reserve requirement ratio, meanwhile, are useful tools to boost the real economy. The main motivation is to boost not only confidence in the economy, but to trigger a real growth response to reassure the world that the country is still on a strong economic footing.

    There has been much ongoing discussion about financial reform in China to ensure a clear path for long-term economic growth. The recent events mean that policymakers will take careful pause in planning future moves to ensure maximum stability. This is because reform that moves too quickly for the system to bear would trigger downside risk, rather than upside potential. Expectations were high for capital account reform, but currently the debate is not in favour of fast reform.

    Impacts on commercial property

    The direct effects on the property market are relatively limited. China is moving towards a consumption-based economy and recent events do not change this. During the stock market boom, there was no corresponding boost in retail sales or consumption. Similarly, we cannot expect a negative effect on retail sales from the stock market decline. In fact, consumer confidence figures actually rose during the stock market slide. Retailers can be assured that negative wealth effects are not significant.

    In the office sector, we note that wealth management firms and financial companies with stock market exposure account for only a small share of occupied space in Tier I markets. In Beijing, for example, only about 1% of space is directly attributable to the brokerage and wealth management industries. Growth in fast-expanding sectors such as IT will quickly absorb any space that becomes available. The start-up world continues to grow at a strong pace, and is on its way to becoming an engine of economic growth for China. However, demand fundamentals in Tier II and Tier III cities will face the same challenges as before the stock market crash. For institutional investors in property, China's Tier I cities still represent an opportunity to gain exposure to a market with deep and wide occupier demand. A more detailed analysis on the fundamentals behind China's growth is included in our recent report on the China60 , released in April of this year.