Greed and fear are the primary emotions driving China’s housing and auto markets today, as China’s lending bubble hits new heights. For ordinary citizens, greed is the key driver:
Average home prices in Beijing rose an eye-popping 63% between October 2015 – February 2017
In Shanghai, one enterprising estate agent (realtor) has married 4 of his clients to enable them to buy a home
Mr Wang’s story highlights the bubble mentality that has taken over the market. As the Daily Telegraph reports, 30-year old Mr Wang:
“Married, and then quickly divorced 4 women to allow them to circumvent strict property laws which seek to cool prices in China’s booming cities, and pocketed more than £8000 ($10k) from each transaction. Once the paperwork is put through, Wang applies for a divorce and puts himself on the market again”.
This is just the latest phase of a market craze, as I noted in November, when one Shenzhen resident told the South China Morning Post:
“The only thing I know is that buying property will not turn out to be a loss. From several thousand yuan a square metre to more than 100,000 yuan. Did it ever fall? Nope.” He and his wife got divorced in February, in order to buy a 4th apartment in Shanghai for 3.6m yuan (US$530k) on the basis that “ If we don’t buy this apartment, we’ll miss the chance to get rich.”
A collective delusion has swept China’s Tier 1 cities, just as happened in the USA during the sub-prime bubble. Amazingly, China’s property bubble is even larger than sub-prime. Unremarkable pieces of land in Shanghai are now being sold at $2000/sq foot ($21500/sq metre), nearly 3 times the average land price in Manhattan, New York.
It is understandable in some ways, as Chinese buyers have never known a downturn, as I noted in September:
“It is also easy to forget that housing was all state-owned until 1998, and still is in most rural areas. Urban housing was built and allocated by the state – and there wasn’t even a word for “mortgage” in the Chinese language. Not only have home-buyers never lived through a major house price collapse, they have also had few other places to invest their money”.
The scale is also much larger, as UBS have reported:
“Chinese banks’ outstanding loans extended to the property industry were between Rmb 54tn – Rmb 72 tn in 2016 ($7.8tn – $10.4tn).”
The chart above confirms this analysis. In reality, the key driver for the bubble has been the growth in lending. As with the US subprime bubble, this has not only impacted housing markets, but also auto sales:
Q1 lending (Total Social Financing) averaged Rmb 2.4tn/month, 2.2x the Rmb 700bn/month level in Q1 2008
Q1 auto sales averaged 1.9 million, 2.06x the 733k/month average in Q1 2008
China’s GDP was only $11.2tn last year, meaning that its property sector loans are more than 2/3rds of GDP.
The problem is that everyone loves a bubble while it lasts. And so, as in the US during subprime, most analysts are keen to argue that “everything is fine, nothing to worry about here”.
In the US, we were told at the peak of the bubble in 2005 by then Federal Reserve Chairman, Alan Greenspan, that house prices would never fall on a national basis
Today, similar wishful thinking dominates, based on the myth that China has suddenly developed a vast middle class, with Western levels of incomes
The problem, of course, as the second chart shows, is that this is also not true. Annual disposable income for city-dwellers averaged just $5061 last year, whilst in rural areas it averaged only $1861. You really don’t buy many homes or cars with that level of income, unless a massive lending bubble is underway.
And this is why fear is the right emotion for everyone outside China. Its lending bubble has driven the “recovery” in global growth since 2009 – pushing up values of everything from homes to oil prices. So anyone who remembers the end of the US subprime bubble should be very scared about what could happen when – not if – China’s bubble bursts.
We can all hope that President Xi’s new policies will enable a “soft landing” to occur, and gently unwind the stimulus policies put in place by Populist Premier Li and his predecessor Premier Wen? But hope is not a strategy. And as the Guardian reported last month:
“Goldman Sachs is said to estimate the chance of a financial crisis in China this year at 25%, and in 2018 at 50%.”
The best view is always from the top of the mountain. That’s probably why the outlook seems so promising for US auto and housing markets. Both appear to be doing well on the surface, but dig a little deeper and concerns soon emerge.
The chart above demonstrates the point, updating the data from my July post with the full-year outcome for 2014. It shows auto sales along the x-axis, and housing starts on the y-axis. The available data starts in 1973, and falls neatly into 4 different eras:
- 1973-84, very volatile, purple. High volumes in 1973, 1976-9, but crisis levels in 1974-5 and 1980-2
- 1985-98, very stable, green. Auto sales generally rising, whilst housing starts were plateauing
- 1999-2007, Y2K and sub-prime mania, red. Easy money pushed volumes to unsustainable levels
- 2008-14, slowing demand, blue. Low interest rates have supported auto sales, but housing remains slow
Back in July, there was already reason for caution. The long-term trend for housing and auto sales had clearly peaked some years ago for common sense reasons, due to the ageing of the BabyBoomers.
The Boomers are no longer buying new houses for the first time, as they are no longer settling down and having children. Nor are they fleeing race riots in the inner cities, and needing cars to drive to the suburbs. Instead, as Dept of Transport data confirms, they are driving fewer miles as they age.
And there is no obvious replacement for their buying power. Of course, the US population is still growing, but the younger population has a quite different profile from the Boomer generation, as the Pew Institute have reported:
- In 1980, only 1 in 10 young Boomers were still living at home with parents. But today we are ‘going back to the future’, with 1 in 5 young adults living at home with parents due to economic pressures. This reduces the need for single family homes, and instead means multi-family units are now (as in the pre-Boomer era) around one-third of total housing starts
- Since 2000, an astonishing 92% of population growth has been in minority communities. And whilst the White population has a median age of 42 years (very similar to that of Europe and Japan), the median age of Blacks is 33 years and for Hispanics just 28 years. This matters in terms of housing and auto markets, as Blacks and Hispanics earn much less than Whites, and have much higher levels of joblessness
Thus the auto market is already seeing the first signs of strain, as the Wall Street Journal reports:
“More than 8.4% of borrowers with weak credit scores who took out loans in the first quarter of 2014 had missed payments by November”
OIL PRICE COLLAPSE WILL HIT HOUSING STARTS, AUTO SALES
Today, there is even more reason for caution, given the collapse of the oil/shale gas bubble. Back in Q3, probably most people disagreed with my forecast that oil prices were about to see a major collapse. But today, major lay-offs are taking place across a variety of industries, as companies rush to adapt to the New Normal world of energy prices:
- This will inevitably reduce housing starts, as workers will no longer be moving to new oil/gas-related jobs
- It will also reduce auto demand – not only from builders for pick-up trucks, but also from laid-off oil workers
The last oil price collapse in 1986 hit Houston, Texas (where I then worked), very badly. Many people lost their jobs and left the state penniless, even posting their house keys back to the bank as the mortgage payment had suddenly become unaffordable. This will likely happen again, right across the oil’/gas belt.
In addition, many will have to return their cars, due to the rise in auto leasing. 27% of new car sales last year were leased, not bought, versus 22% in 2012 and just 17% before 2005. But it is hard to maintain the typical $199/month payment if your job has just disappeared.
“Recent economic reports suggest a bleaker picture for housing…. Some of the weakness reflects the cold weather in much of the country. However, higher home prices and mortgage rates are taking a toll on affordability.”
This was the sober report yesterday from the chairman of the authoritative S&P Case-Shiller Home Price Index, adding that “the strongest part of the recovery in home values may be over”.
The problem is summarised in the chart above, which shows the ratio of earnings to average US house prices for the main racial groups:
- The ratio for whites is similar to the average ratio at 7.7x, with that for Asians at 6.4x
- But the ratio for blacks is 9.5x, and for Hispanics it is 10.4
Essentially, as the blog noted back in December, the US now contains two distinct groups with very different profiles:
- Whites earn $42k/year and have median age of 42 years: Asians earn $49K and have median age of 37 years
- Blacks earn $33k and have median age of 33 years: Hispanics earn $30k and have median age of 28 years
- There are 84m white and 6m Asian households: there are 14m Hispanic and 16m black households
This demographic clearly explains the problems of today’s housing market. The wealthy ageing white BabyBoomers have a similar profile to Europeans. Their children are leaving home, and they are starting to enter retirement. Thus they are not going to provide much support for the housing market.
The younger poorer black and Hispanic populations could provide some support, but they can’t afford current price levels. Credit standards have tightened since the subprime era, and few lenders will provide mortgages at multiples of 10x earnings any more.
Equally important is that today’s house price to earnings ratios are still too high. They are all 20% higher than average ratios between 1979-99, before the housing bubble began.
Declining fertility rates are also having a major impact. Census Bureau data shows there are now only 21m households in the prime 25-34 age group of first time buyers, and just 22m in the 35-44 age group. Whereas there are already 28m households in the 65+ age group, and 23m in the 55-64 cohort. The result is that home ownership rates are already back at 1996 levels, and set to fall further.
Demographics are clearly driving the housing market, despite all the efforts of policymakers to turn back the tide. Smart companies will adjust their expectations and strategies accordingly.
Housing used to be the key driver for US chemical demand in the SuperCycle, and went into overdrive in the subprime era between 2003-6, when housing starts rose to 2 million/year. We don’t yet have December’s data, but we already know that 2013′s total will be only half this level, despite all policymakers’ efforts to revive the bubble.
Rather than face reality, however, policymakers instead continue to promote the idea of a ’housing recovery’. The reason is that a new downturn in housing will explode the myth that current policies can somehow return us to SuperCycle growth levels. But memories are not that short and people will not easily forget what happened in the sub-prime bubble, as we documented in chapter 2 of Boom, Gloom and the New Normal:
- The overall value of US housing doubled from $10tn to $20tn between 2000-5
- Americans extracted $564bn/year in mortgage equity between 2001-5 according to the Federal Reserve
- This added an average of 6.7% to their disposable income
- Rising home prices also encouraged a ‘wealth effect’, causing the saving rate to drop from 4.7% to just 1.6%
The blue line on the above chart is a graphic reminder of the madness that occurred. Created by Prof Robert Shiller, probably the leading expert on US housing markets, it shows the amazing bubble that caused prices to double from their long-term average in just 6 years.
Policymakers are now busy trying to inflate a second bubble, but this time they have major headwinds to overcome. ”Reversion to the mean” is always the most reliable investment strategy. And plain common sense suggests that it is unlikely policymakers will be able to sustain today’s prices for much longer. The trend is clearly downwards towards the long-term average, as the blog discussed when last updating the chart in July:
- Since then interest rates (green line) have risen quite sharply, and are now nearly double their lows at 3%
- As a result, US mortgage approvals are at a 13-year low as buyers have disappeared
- The recent opportunistic buying by speculative would-be landlords is also coming to an end
- Whilst home ownership rates have been falling for 10 years, and are now back at Q3 1996 levels
The best summary of the otulook, as often, comes from Prof Shiller and the latest S&P/Case-Shiller house price report. In discussing the slowdown of prices since the summer they warn that the “monthly numbers show we are living on borrowed time and the boom is fading“.
The blog is changing its regular presentation of US house price movements, to mirror that used for auto sales. This should help to identify month-by-month changes.
It also means there is no need to use seasonally adjustmed numbers. These are guesswork at the best of times. And in Q1 they have been tested to the limit, due to the abnormally warm weather in most of the US.
The chart is based on the S&P Case-Shiller Index and shows:
• 2012 prices (red square) in Q1 were 3% below 2011 levels (green line)
• This is similar to 2011’s 3.6% fall versus 2010 (blue)
• The 2010 average was 20.4% below 2006’s peaks (black)
Equally, S&P note that prices “ended Q1 at post-crisis lows”, and add:
“Since we are entering a seasonal buying period, it becomes very important to look at both monthly and annual rates of change in home prices in order to understand the broader trend going forward.”
The blog hopes its new format will help readers to do this.