China: The Next Bubble To Burst?

by: Ariel Aharonovich

Well,well... after Italy has become a major concern, what can we say about China becoming a much bigger one?...

After publishing earlier this week some new, very restrictive, rules for its real estate sector, China reaffirmed today its growth target for 2013, setting it at 7.5%.

Though this slightly below the 7.8% growth recorded in 2012 this is far away from the around 10% growth rate that the we witnessed over most of the last decade.

Putting it very bluntly: China is not the growth engine the world is hoping for it to be.

In response to the harsh limitations that were imposed on the real estate sector - presumably the "engine of all engines" in regard to the Chinese economy - the main equity indices recorded sharp declines; the CSI300, for example, has shed 5% (!). This crash has been unsurprisingly led by construction and building companies.

As a matter of fact, almost all Asian markets suffered heavy losses, except for the Japanese equity market which apparently operates in a parallel world to ours...

The Chinese government move was unexpected, especially in its very detailed, concrete, steps directly aiming at slowing - perhaps even stopping - the development of the mega real estate bubble that got out of control; some may add - long ago.

While specifically addressing these issues the message is loud and clear: no more. The Chinese authorities do not intend to let this bubble keep on inflating and are determined to stop it, hopefully on time. But is it???

The new limitations/rules apply to the following:

1. Restrictions on purchasing a property. From now on, the restrictions won't apply only to urban, most populated, regions but on a much wider areas and to an extended scope. Not only a secondary property would apply to the restrictions but also a primary house would be subject to restrictions from now on.

2. A 20% tax imposed on capital gains that are a result of investing in real estate. This new tax is replacing the old 1-2% tax that had to be paid on the purchase price of a property. This new tax regime will increase the tax burden relevant for real estate transactions substantially.

Furthermore, since this new tax will fall under the responsibility of the buyers it would most probably decrease the demand for second-hand properties significantly.

3. Tier-1 and Tier-2 cities get a "special treatment" which includes (A) a higher capital requirement and (B) a higher interest rate on mortgages. More details regarding this "treat" should be published soon.

Those new steps are a very serious steps that should not be ignored or overlooked.

The common view is that these steps would have significant effects on both the demand as well as the supply.

Prices of new, first-hand, properties are expected to decline and, consequently, also the volume of second-hand transactions.

One may wonder: Why do they take such actions?

In a strange coincidence the latest "60 minutes" on CBS News, just gave us the answer. In its "China's real estate bubble" broadcast CBS describes an astonishing picture of the "ghost cities" that fill China.

Although CBS isn't the first television network to expose this situation it's nothing but amazing to see it over and over again.

Many cities have been built in order to "incentivize" the Chinese economy and to attract (mostly new) population to settle in.

The apartments were sold to "investors" that de facto buried their money in these cities that are non-populated and getting older although they are "new"...

Some of these cities are standing steal with no change whatsoever taking place.

Fancy malls, completely "sold", filled with "famous", well known, brands are waiting for buyers (at best) or simply to get opened...

It turned out that these malls and brands are nothing but a big fraud, a too-creative picture that aims at attracting new residents. Luckily (?), not many people are falling for this scheme.

In the "60 minutes" broadcast you may listen to Chinese people speaking about many investors belonging to the middle-class that put the entire savings of their families into these new, developing, areas while hoping and expecting these cities to be the next big thing.

Life savings had been invested into properties that are empty and generate no income at all.

This is how the world's main engine is looking like.

Is there a real estate bubble in China? - if your answer hasn't been "YES!" thus far I assure you that it will be after watching this "60 minutes" broadcast; it's a really must-watch piece!

So the question isn't whether there's a bubble or not but are the new steps taken by the Chinese authorities able to shrink this bubble or is it going to burst in what may be a massive blowout for the Chinese, and as a result to the world's, growth.

Beware of investing in China through GXC, FXI, MCHI, XPP or FXC. Instead you may wish to consider shorting China through FXP or YXI at some point but at the moment my reccomendation would be to simply stay away of this very promising but too risky giant.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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