Is the 30% rebound in Asian high yield sustainable? We believe not.

• Property demand remains fragile despite the string of supportive policy measures and the reopening from Covid-19 curbs.

• With China’s housing market yet to find a stable footing, a short-term rebound does not seem plausible at the current juncture.

• Developers have continued to experience rating downgrades or defaults on their debt obligations in recent times, showing the limitations of government intervention.

• We believe that the market is likely running ahead of itself, painting an extremely optimistic scenario that everything could quickly come under control.

• We maintain our defensive stance on Asian high yield bonds and recommend investors to gradually reduce their positions.

With China unleashing a wave of supportive policies for the property sector alongside the reopening of its economy from Covid-19 curbs, Asian high yield bonds – as measured by the Bloomberg Asia USD High Yield Bond Index – have surged by around 30% since November 2022 (Figure 1).

However, in our opinion, the rally is likely to be short-lived. We maintain our defensive stance on Asian high yield bonds, and outline our rationale below.

Figure 1: Asian high yield has since rallied sharply

(Related article: Downgrading Asian high yield: Why we aren’t taking this risky bet anymore)

Property demand remains fragile

The first shot in the arm for the property sector came from the banking regulator and the central bank on 11 November 2022. They announced 16 measures designed to relieve the credit crunch in the property sector, and ensure developers complete and deliver presold homes. Furthermore, recent market headlines suggest that China is considering relaxing its stringent “three red lines” policy for some developers, representing a significant policy shift in the sector. All these are sending signals that China’s crackdown on the property sector may finally be over.

In our view, the shift in policy tone does not mean that the deepest problems in China’s property sector are gone too. The string of supportive policy measures and the reopening from Covid-19 curbs have failed to restore confidence in the housing market. Where it stands, property demand remains fragile.

China’s reopening comes at a time when external demand is weakening as the global economy heads towards a slowdown. This poses risks to China’s economic prospects, consequently affecting prospective homebuyers’ financial situation and their willingness to purchase big-ticket items amidst the uncertainties.

Besides, homebuyers have continued concerns over the developers’ ability to deliver homes that have been pre-sold. It will take time for developers to finish the uncompleted projects, especially if the developers themselves first need to be restructured. Take Evergrande for example: A year on since defaulting on its debts, the Group is still trying to work out a restructuring plan. Also, we think that there needs to be a steady stream of completions in order to meaningfully restore confidence in the housing market.

Don’t expect a short-term rebound

On top of that, property indicators suggest the sector has not bottomed out yet. New home prices in 70 Chinese cities surveyed by the National Bureau of Statistics are experiencing an extended period of year-on-year declines (Figure 2). While new home prices in January 2023 were up 0.1% month-on-month versus a 0.2% slide in December 2022, we note that one positive data point does not make a trend. In our view, the confidence crisis is creating a vicious cycle, in which homebuyers are holding themselves back from entering the market, waiting for prices to fall further.

Figure 2: Home prices have been falling persistently

On the supply side, as developers struggle to sell homes, inventory has been piling up. Home inventory, measured in terms of gross floor area, is near a five-year high, after a strong 10.5% surge year-on-year in 2022 (Figure 3). Inventory de-stocking through price cuts could weigh on China’s home prices. As such, property inventory – which has become excessive – needs to unwind in an orderly manner, or else the sector could risk having a systemic crisis.

Figure 3: Inventory has been piling up

While China is trying to manage the oversupply of homes and limiting price declines in some areas (where developers have been blocked from slashing prices by more than 15%), we think it is still too early to conclude that a ‘soft landing’ in the housing market can be engineered. Ultimately, it is dependent on whether confidence could be restored successfully before it becomes too late.

By and large, we are keeping a wary eye on the recovery story. China’s housing market has yet to find a stable footing, suggesting that a short-term rebound does not seem plausible at the current juncture. The government, perhaps, has to do more. Policy impact will also take time to materialise, meaning that the housing market’s recovery should be gradual and potentially bumpy.

Default risk remains persistent

Furthermore, we have continued to see developers experiencing rating downgrades or defaults on their debt obligations in recent times, showing the limitations of the plethora of government attempts to ease the liquidity crunch in the property sector. Notably, Times China – China’s 51st largest developer by contracted sales in 2022 – defaulted on two US dollar (USD) bonds in January 2023 and is halting payments on offshore notes.

Could the last wave of downgrades or defaults in China’s property bond market be over? The short answer is: unlikely.

For a start, financing tools that have been recently revived by the Chinese government, as termed by the “three arrows” (i.e. bank loan, bond issuance, equity finance), are unlikely to benefit every developer. Only developers – both state-owned and private-owned – that have been classified as ‘good quality’ by the government are expected to receive broader support. Meanwhile, others are likely to be left behind.

Beyond this, contracted sales – a key driver of developers’ liquidity profiles – are in the doldrums. The nation’s top 100 developers are already experiencing a long period of pain with double-digit sales decline year-on-year (Figure 4). While sales in February rose, the rebound may not be sustainable as China’s housing market yet to find a stable footing.

Figure 4: Sales of top 100 developers consistently face double-digits negative growth

Furthermore, land purchases plummeted by over 50% year-on-year (Figure 5). We believe that this is a sign of not only weak sentiment among developers, but also tight liquidity. With developers reluctant or lacking the ability to buy land for new buildings, contracted sales growth is expected to remain subdued moving forward, resulting in the potential for deterioration of liquidity.

Figure 5: Land sales have slumped

In the near term, China’s property bond market continues to face a challenging hurdle of offshore bond maturities. Out of these, Country Garden stands out as a big-name (Figure 6). Despite the recent repayment of its January 2023 bonds, the unclear industry outlook and the Group's large scale suggest that the impact of new policies and rescue measures might have their limitations. We also keep in mind that Country Garden’s focus is on China’s more challenging tier-3 and tier-4 cities.

Figure 6: Country Garden has a relatively larger amount of debt due

The longer term outlook of property developers is also bleak. China’s shift to a top-downed state-controlled economy is expected to threaten the long-term profitability of private developers. At the annual National People’s Congress, authorities have also remarked that they will remain tough on the sector – we believe policy is unlikely to be relaxed by a huge extent.

Additionally, the unfinished homes and falling home prices have spooked some potential homebuyers, who now see no point in owning property and would rather rent. China has plans for those looking to rent – it aims to build 6.5 million public rental housing in 40 cities by 2025.

The Asian high yield bond market is likely running ahead of itself

From the perspective of valuations, there has been a broad and fairly indiscriminate recovery in China’s property bonds. Despite poor property indicators and the lack of substantial recovery in liquidity profiles of developers, the percentage of Chinese property bonds trading above 50 cents on the dollar (in the Bloomberg Asia USD High Yield Bond Index) has increased dramatically to 76% at the time of writing. As at end-October, which was the peak of the sell-off, the percentage stood at just 9% (Figure 7).

Figure 7: A broad and fairly indiscriminate recovery

Meanwhile, Asian high yield credit spreads have narrowed by nearly half since November 2022, and are now returning to levels seen during the early days of the Evergrande crisis, one that was initially thought to remain as an idiosyncratic event – but we all know how that turned out.

Figure 8: Spreads have narrowed significantly from the peak

Overall, we believe that the market is likely running ahead of itself, painting an extremely optimistic scenario in which risks are dissipating rapidly and everything could quickly come under control. In reality, while the worst may be over, conditions in China’s property sector do not seem to be going all the way back to where it was before.

There are still lingering problems in the housing market, implying a long road ahead to reach a meaningful recovery. As the confidence crisis continues to be detrimental to housing prices and contracted sales, the actual pace of recovery could trail high expectations of a short-term rebound. Once the market realises that, the rally should run out of legs and correct itself.

Investors should redeploy their capital elsewhere

Given our view of the recent sharp rebound being unsustainable, we maintain our defensive stance on Asian high yield bonds. Now would be an opportune time for investors to gradually cut their positions. For investors who do not have any positions in the Asian high yield bond market, we recommend them to stay clear.

In our view, compelling investment opportunities – which are backed by solid fundamentals – can be found elsewhere for fixed income. Amidst the global macroeconomic uncertainties, we opt to stay defensive, with a preference for high-quality, short duration bonds.

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