Goldman Sachs is investing in Chinese real estate debt, even as that debt is currently one of the most battered assets in global financial markets.
The debt crisis and escalating default risks threatening China Evergrande Group, China Properties Group, and Sinic Holdings are creating enormous problems for the nation’s real estate sector. But the U.S. investment titan believes that the market is overestimating a contagion risk, which is producing a wide range of opportunities.
Angus Bell, a member of Goldman’s portfolio-management team, revealed that the financial institution has been adding a “modest amount of risk” through high-yield bonds issued by the nation’s property developers and denominated in U.S. dollars. Goldman Sachs also has been pouring into the Chinese government’s local currency bonds, mainly because the People’s Bank of China (PBoC) is offering liquidity to local economies amid a slowdown.
“Ultimately, the property sector has been the key driver of Chinese growth over the past two decades,” Bell told Bloomberg. “It’s unlikely the government will tolerate the impact on growth that would come about if it were to allow such a large number of developers to fail. The breadth of distress that the market is now pricing, it’s starting to look significantly out of alignment with the true extent of distress.”
He noted that fiscal and monetary policymakers would ensure ample liquidity conditions throughout the economy as part of their post-pandemic mandates.
The bank has conceded that investing in the debt is more challenging, but that doesn’t mean that it’s “uninvestable.”
“We would push back quite vigorously on the sweeping statement that China is ‘uninvestable,'” Timothy Moe, chief Asia-Pacific equity strategist for Goldman, said in October.
China’s Real Estate Bust
Economists say that the booming housing market that supported immense growth for more than a decade has come to an end. This could have long-lasting consequences for the broader economy.
While Beijing is attempting to pull the levers to slow the nation’s property sector, the soaring debt levels could weigh on China for many years to come, according to analysts.
Although Evergrande’s troubles appear to be abating as it continues to scrape together more cash to cover its payments, industry observers are pointing to the growing number of other property developers enduring debt woes.
In its latest biannual financial stability report (pdf) released on Nov. 8, the Federal Reserve warned of China’s property difficulties potentially spilling over to the United States. From Evergrande Group rattling international markets to domestic developers being unable to repay debts, the U.S. central bank is concerned that the size of its economy, financial system, and international trade links could contribute to underlying issues on the New York Stock Exchange.
“Stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States,” the Fed wrote.
Chinese real estate developer Kaisa Group Holdings saw its Hong King-listed shares halted on Nov. 5, after it was reported that the business had missed a payment on a wealth management security. Reuters also reported on Nov. 8 that Kaisa is seeking financial support to help pay loans, employees, and suppliers.
These developments have led to tumbling property bonds. Country Garden and China Vanke, two of the largest property developers in the country, have witnessed their largest declines in bond yields on record. Investment-grade bonds issued by Shimao also fell.
“The problem is, it is getting systemic,” Viktor Szabo, a London-based emerging market portfolio manager at abrdn, told the newswire. “The big issue is that we don’t know what (Beijing’s) ultimate plan is … and how long can you hold on to the view that China can handle it?”
Wall Street Goes Bullish on China
Many Wall Street firms have become bullish on China in 2021, despite the plethora of challenges gripping the economy.
Since June 2020, investment management juggernaut BlackRock has been selling China to investors. As a result, the company has established a significant presence in this foreign market, becoming the first foreign asset manager to control a wholly owned business in the nation’s $3.6 trillion mutual fund industry. It has also launched a China equity fund that has generated more than $1 billion from approximately 111,000 investors.
J.P. Morgan Asset & Wealth Management Chief Executive Mary Erdoes told attendees at the CNBC Delivering Alpha Conference in October that “China has gone on sale,” making the case to attain exposure to an economy that’s garnering a vast middle-class.
Herald van der Linde, the head of equity strategy for Asia-Pacific at HSBC, echoed these sentiments by highlighting opportunities and equities “at reasonable valuations.”
“Investors are too bearish about China stocks,” van der Linde said in a note. “Yes, China is struggling with growth and a stronger U.S. dollar is not good news for China’s stock markets. But that’s now well-known and is priced in. Even good, blue-chip stocks are now trading at attractive valuations.”
But not everyone on Wall Street is in agreement.
Chamath Palihapitiya, the Social Capital founder and chief executive at Delivering Alpha, thinks that the “game is over” on China. He urged investors to be cautious and skeptical about asset management firms placing massive gambles on China.
“There are hundreds of billions in foreign capital, and you can charge fees and can generate profits. But I think what you see is that game is over,” Palihapitiya said. “China Inc. One country, one company, one CEO.”
Global holdings of Chinese stocks and bonds have blossomed in 2021, according to Financial Times data. Despite regulatory crackdowns, immense volatility in the equities arena, and the real estate market’s debt crisis, international investors have accumulated more than $120 billion in 2021, topping holdings at $1.1 trillion.
The Chinese yuan has been one of the supporting factors for investors scooping up Chinese assets, according to market observers. The yuan has strengthened against the U.S. dollar in 2021, rising by about 2 percent year-to-date.
Is There Reason to Be Bullish on China?
In September, Goldman Sachs slashed its projections for China’s economic growth in 2021. The Wall Street banking behemoth is now forecasting that the nation’s gross domestic product (GDP) will advance by 7.8 percent in 2021 compared to 2020, down from the previous 8.2 percent prediction.
Financial services firm Nomura has also trimmed it expectations for China’s GDP growth rate to 7.7 percent in 2021, down from the 8.2 percent that it had previously anticipated. Morgan Stanley has reduced its outlook to 7.9 percent from 8.2 percent, while JPMorgan Chase has decreased its GDP forecast to 8.3 percent from 8.7 percent.
Fitch was a little more optimistic, lowering its growth rate expectations to 8.1 percent from 8.4 percent.
They all shared the same reasoning for the change: a real estate slowdown, intensifying energy hurdles, and the supply chain crisis.
“We believe it is unrealistic to expect China to maintain high and stable growth as Beijing delivers substantial shocks to both supply and demand sides,” Nomura Chief China Economist Ting Lu said in a note in September.
Commerzbank is penciling in a growth rate of 8 percent for China’s GDP in 2021.
“Leverage remains a constraint. Policymakers will be paying close attention to debt levels as we see further normalization of China’s monetary policy. Credit risks could emerge for some sectors during this process, with the potential for credit events or defaults,” Hao Zhou, senior emerging markets economist at Commerzbank, said in an outlook.
Inflation is another growing concern for Beijing. According to the National Bureau of Statistics (NBS), the annual inflation rate surged to a 13-month high of 1.5 percent in October, more than double the reading in September. Producer prices soared at an annualized rate of 13.5 percent in October, up from September’s 10.7 percent gain. Both numbers topped market estimates.