Macau has long been regarded as a barometer of China’s economic activities. This makes sense as long as much of China’s economy continues to be driven by construction and manufacturing. That’s because few “internet bosses” frequent casinos to entertain business associates. It’s the “coal bosses,” “steel bosses” and “real estate bosses” who readily throw down large sums of money in the VIP rooms with their guests to lubricate business deals. Keep in mind that Macau is not -- and likely will never be -- Las Vegas. Macau is a place dominated by well-heeled gamblers not those looking for $5 slot machines.
In that sense, investors and economists are right to trumpet this week’s gross domestic product report that showed China’s economy expanded a stronger-than-forecast 6.9 percent in the second quarter. Gaming revenue in Macau’s fabled VIP rooms has bounced back from a long period of negative growth between mid-2014 and the end of 2016. In the second quarter, gaming revenue from VIP players rose the most in three years, jumping 38 percent from a year earlier. That’s almost 27 percentage points more than the growth in the non-VIP, or mass customer, segment. This acceleration sends a strong signal that China’s old economy is not only back, but is strong and booming.
Although officials have managed to steer China’s economy into a soft landing, the question is, at what cost? The reported GDP data for the first half of 2017 suggests that the three longtime engines of growth -- construction, manufacturing and exports -- remained key supports, buying the Chinese government time to enact structural reforms. Domestic consumption driven by the middle class, however, was stagnant, and leverage is high, which is why many, including the leadership in Beijing, are worried about the structural challenges facing China. During a two-day closed-door conference on financial regulation last week, China’s leadership sent a strong message to the market that deleveraging and strengthening regulatory oversight were the themes for the financial sector in the next five years. Immediately after, coincidentally, the government cut off some funding for Dalian Wanda Group’s overseas acquisitions because of concern that the company is too highly levered.
The housing market may hold the key to where China’s economy is headed. Other than housing, there are few investment options available to most Chinese citizens, which helps explain why home prices keep rising, despite the government’s efforts to contain the speculative frenzy. It can be said that home buyers have developed a sort of psychological resilience to more restrictive policies, even viewing them as “buy signals.” Because it is getting more difficult to buy and sell in the more tightly regulated markets, speculative buyers are moving into the smaller cities surrounding the large cities.
According to the National Bureau of Statistics, new home sales jumped 13 percent in the first half from a year earlier, driven by a 27 percent increase in lower-tier cities. Since there is no evidence of any significant net increase in the population of those lower-tier cities, most of the increase in purchases likely came from speculative investors in larger cities nearby. A simple, yet effective, analysis that measures affordability by median household income divided by mortgage expenses and rental yield reveals a striking fact. Most homes are being bought in China not as residences by the working middle class, but by speculative investors. People’s Bank of China data suggests the average household is more indebted than ever. The data show that consumer loan growth is up 24 percent from a year earlier at the same time that net savings deposits are down 5 percent.
Auto sales are suffering as a result of rising household debt. Dealerships in China will say that higher monthly mortgage payments have made consumers less willing to buy or upgrade their cars -- the second-biggest item for consumer discretionary spending, Car sales are up just 1 percent this year, the slowest since 2009. Even the less cyclical high-end segment -- German luxury cars, for example -- has started to see growth decelerate.
As Wall Street economists get busy revising upward China’s growth outlook in the second half, investors would be well-advised to exercise caution.
By Li Junheng
Li Junheng Li is the founder of JL Warren Capital LLC, an independent equity research firm focused on Chinese companies and the Chinese economy. -- Ed.
(Bloomberg)