Summary:

• The main approach to the current housing policy relaxation is to encourage households to increase their debt and leverage ratio, but we believe that its effect is relatively limited. With the current high levels of household debt ratio in China, by accelerating the growth rate of household income and raising the expectation of this could increase the willingness and capacity of household debt to be further increased. However, judging from the growth of personal income tax in recent years, household income growth has slowed down significantly.

• The relaxation of purchase restrictions boosts secondary housing transactions in first and second tier cities but will have a limited impact on improving overall new home sales. Secondary housing transactions are more about transferring savings and leverage between families but have minor impact on improving the overall household leverage ratio. At the same time, the increasing proportion of secondary housing transactions has further suppressed the demand for new homes. The relaxation of purchase restrictions in first and second tier cities has also had a crowding-out effect on housing demand in bordering third and fourth tier cities. As of today, most of the property sales come from third and fourth tier cities.

• Since late May, the government's bond issuance has accelerated. Investors should pay attention to the future direction of how these funds will be spent. One possibility is to increase investment in infrastructure and manufacturing output. Another possibility is to directly improve household income and employment rate. We believe that the latter situation will have a stronger effect on the domestic stock market and property market which both will drive China's economic growth.

• On 27th May, President Xi Jinping proposed the following at the collective study meeting of the Politburo of CCPCC: Promote high-quality and full employment, and continuously enhance the sense of achievement, happiness, and security among Chinese workers. Therefore, we should also see whether the central government is able to introduce relevant policies to improve income and employment in the future.

• The liquidity of overseas stock markets continues to remain loose, and US stocks continue to rise. This trend may continue before ON RRP dries up.

• We believe that the trend of gradual relaxation for domestic policies is certain in the near future, hence A-shares and Hong Kong stocks are unlikely to hit a new low, and buying on correction remains as one of the trading strategies.

• There are requirements for correction after the substantial increase in previous commodity prices. The focus of attention will be whether domestic policies will be able to reduce the investment in the new energy sector, and whether Europe and the US will further increase trade restrictions on China's new energy product exports. If so, we may see a further decline in base metals.

Previous Views:

Since the last week of April, overseas investors have become optimistic on the domestic stock markets and economic sentiment due to the expectations of policy relaxation. However, compared with the various indicators back in 2015, the current residents and local governments are unable to increase leverage. Therefore, unless the central government directly invests a lot more funds as compared to the 2015-2019 cycle, it is unlikely to promote the recovery of the housing market. In general, we believe that the probability of large-scale economic stimulus policies in China is low. Therefore, we still believe that this round of A-shares and Hong Kong stocks is merely an oversold rebound.

Views in June:

I. Chinese household leverage is unlikely to rise higher again.

Since May, the introduction of easing policies has mainly focused on the housing sector, and the core of easing policies is still based on the hope to increase household leverage by lowering down payments and mortgage rates on new loans, thereby helping to improve the economy and government revenue. However, in the current domestic economic environment, we believe that the effects of these policies will be limited.

First, we believe that increasing household leverage cannot be achieved simply by reducing downpayments and mortgage rates. It is true that these policies are effective in increasing household leverage when it is low. However, given that the overall leverage ratio of Chinese residents is already very high and cannot be further improved in the short term (Figure 1), the effectiveness of this policy measure is questionable.

With the current level of household debt ratio in China, only by accelerating the growth rate of household income and raising the expectation of this can increase the capacity of household debt. In the scenario of weak or declining income growth, it is difficult to increase household debts even if the downpayment and interest rates are lower. Take Japan as an example. After the 1990s, Japan implemented a ZIRP but could not further increase the total debt level of Japanese residents. The main reason is that after the 1990s, the disposable income level of Japanese residents stagnated for a long time (Figure 2).

The current situation is that the growth rate of Chinese residents' income has shown a significant slowdown in recent years, especially the slowdown on the income growth rate among the middle class and above. This can be seen from the amount of personal income tax paid by Chinese residents (Figure 3): With a stable personal income tax rate, the amount of personal income tax paid by Chinese residents has stopped growing since 2022, reflecting the stagnation of residents' income.

II.   Current policies have limited impact on improving new home sales.

In addition, some cities have recently relaxed their local real estate purchase restrictions. We believe that this policy will have a certain boosting effect on second-hand housing transactions in some first and second tier cities but the improvement in new housing transactions is limited.

As mentioned above, due to the weak growth of overall income and limited ability and willingness to increase leverage, the marginal improvement brought by the relaxation of purchase restrictions may only appear in some first and second tier cities, or even only in specific areas of these cities. This improvement in demand is more likely to be achieved through secondary housing market transactions within the residential sector. This is due to the fact that the current overall housing ownership of Chinese households is already very large to begin with, with an average housing area of ​​41 square meters per capita, which is already at the forefront of the world. As the overall resident leverage ratio cannot be further increased, housing demand will eventually become leverage transfer between families, ie. through secondary housing transactions. This is also the case in the countries of maturing housing markets such as Western Europe, the US and Japan. We have seen that after the recent relaxation of purchase restrictions in Shanghai, secondary housing transactions have become more active, but first-hand new home sales have not improved (Figure 4). Moreover, the situation in which the proportion of secondary housing transactions continues to rise and exceeds that of new home sales is also a common phenomenon in many other first and second tier cities (Figures 5 and 6).

In most third and fourth tier cities, new and secondary housing transactions continued to decline. Some third and fourth tier cities adjacent to first and second tier cities that have relaxed purchasing restrictions are also facing "squeezing out" housing demand by their neighbours. As for developers and property construction investment, the original intention of policy relaxation is to speed up the clearance of first-hand new housing inventory, while stabilizing developers' land acquisition and construction investment. The increase in the proportion of secondary housing transactions and the stagnation of the overall household leverage ratio have created greater obstacles to the realization of these policy intentions. Whether in terms of housing sales or investment amount, third and fourth tier cities are still the largest part in China's housing market (Figure 7). If the policy does not help improve new home sales and developer’s inventory reduction in third and fourth tier cities, then its effect on boosting the real economy will be very limited.

Figure 7. Major part of Chinese housing and construction market shares are still in lower tier cities

II.  Government bond issuance has recently accelerated, attention should be towards the direction of the future government funding project.

Since late May, the Chinese government's bond issuance has accelerated, mainly reflected in the significant increase in the issuance of special treasury and LG special project bonds. According to our calculations, in May, the net increase in government debt exceeded RMB1.4 trillion, including RMB690 billion in treasuries, RMB630 billion in LG bonds, and RMB580 billion in policy bank bonds, while construction investment bonds continued to shrink (Figure 8).

Although the acceleration of government bond issuance will certainly help the economy in the coming months, investors will still need to pay close attention to the direction of how these funds are to be spent.

One possibility is that these funds will continue with the previous policy preferences to invest in infrastructure and to support the so-called “new manufacturing productivities”. This will undoubtedly further increase the growth rate of domestic industrial output and manufacturing investment, and to a certain extent slow down the decline in housing investment growth. It also means that the price and corporate profit decline caused by insufficient final demand will continue, so this will not have much boosting effect on corporate cash flow and stock market earnings.

Another possibility is that more fiscal investment will be made to improve household income and employment. On 27th May, President Xi Jinping proposed at the collective study meeting of the Politburo of CCPCC: Promote high-quality and full employment, and continuously enhance the sense of achievement, happiness, and security of Chinese workers. Therefore, we should also see whether the central government can introduce relevant policies to improve individual income and employment in the future. If there are such policies in place, it will have a more positive and effective driving effect on both the domestic stock market and real estate market that exceeds current expectations.

II.                   Market strategy

The liquidity of overseas stock markets continues to remain loose, and US stocks continue to rise, but the gains are more significant in individual large-cap growth stocks. These stocks driven by this liquidity may continue to lead the rally for some time, but risks are also accumulating. Short-term US economic indicators have weakened, but they are offset by the optimistic expectations of the Fed's rising probability of rate cuts. The Fed's reverse repurchase (ON RRP) on its balance sheet has hit a new low of US$380 billion, but in the short term, funds can still be injected to maintain a relatively loose funding situation.

A-shares and Hong Kong stocks rose and fell, mainly affected by the inflow and outflow of overseas funds. We believe that the trend of gradual relaxation of domestic policies in the near future is certain, so A-shares and Hong Kong stocks are unlikely to hit a new low, and buying on correction is still a trading strategy that can be considered. However, the height of the rebound still depends on whether the government funds will be invested to support the production side or demand side. If it is the latter, there will be more room for rebound. Otherwise, the stock market may still show a range of fluctuations.

There are requirements for correction after the large increase in previous commodity prices. The focus of attention is whether the domestic policies will reduce the investment in new energy sector, and whether Europe and the US will further increase trade restrictions on China's new energy product exports. If the above situation occurs, there will be greater downward price pressure on base metals that have seen substantial price increases in the past.