Even optimistic investors are starting to lose faith in China

Share

China has a problem: It is losing its supporters.

As the country's once-stellar economic growth slows to levels once deemed unacceptable among economists, a number of investors had been maintaining bullish views on the country and its long-term potential.

Now, some of these views are starting to shift, raising concerns that the former engine of the global economy is becoming one of its key risks.

Mark Mobius, manager of the Templeton Emerging Markets Fund and for decades one of the top names in global investing, has lowered his exposure to China to below 16 per cent, as of the end of March.

That's down significantly from a weighting of more than 22 per cent a year ago and below China's 18.5-per-cent weighting in the benchmark MSCI Emerging Markets Index.

As well, none of the top 10 holdings in Mr. Mobius's fund are based in China, versus four Chinese companies that crack the index's top 10.

To be sure, China has long attracted its share of skeptics who saw a toxic mix of local-government debt, entrenched corruption and massive overbuilding.

For example, famed short-seller Jim Chanos of Kynikos Associates has been warning of a real estate bubble in China since 2009 and has been betting against Chinese banks.

China's stock market has been feeding much of the broader investor skepticism. The Shanghai stock exchange composite index has fallen more than 40 per cent since 2009 and is no higher today that it was six years ago. Investors have been pulling money out of Chinese equity funds at a brisk pace, suggesting that small investors are losing patience.

But now, China is even starting to weigh on the optimists.

"Over the past year, we've written that Chinese growth was more stable than the market believed," said strategists at Pavilion Global Markets, in a note. "Over the past several months, however, we've grown increasingly concerned that the housing pillar is becoming shakier."

The strategists contend that China's property market is much more difficult to manage than many of the country's other financial challenges. Price increases within leading cities are slowing, which suggests that property growth has peaked. Among less-developed cities, prices are rising at an even slower pace.

Things could get worse: Sales volume has fallen 19 per cent over last year and "floor space" construction has fallen 23 per cent, according to The Wall Street Journal.

"To be clear, our view is not that this is China's property bubble day of reckoning and that prices will never accelerate again," the Pavilion strategists said. "Rather, we feel we have reached a downturn in this highly cyclical property market."

That raises two big concerns.

First, the property market has deep ties to China's financial sector – local governments rely upon property to repay debt and the banks accept it as collateral – which means that a sharp downturn will raise the chances of wider financial instability.

Policy makers can help alleviate the situation, but their choices aren't good ones. Broad support will hurt the credibility of recent financial reforms, while supporting only the more important financial institutions will make any rescue look disorderly.

Second, the Pavilion strategists believe that a property market downturn will affect China's broader economic growth. That's because 13 per cent of urban workers are employed in the construction sector and urban residential investment accounts for nearly 12 per cent of China's gross domestic product.

"One of the pillars of our view over the year has been that property was still growing strongly and that it would help stabilize growth," the strategists said. "A downturn in property changes that tailwind into a headwind."