We're going to be subjected to an endless stream of warnings over the destabilising effects of Brexit in the run-up to June's referendum, but investors may need to look a little further east than Westminster for the likeliest source of market instability. For all the blather over the in/out vote, China's bid to reconcile monetary policy with attempts to shore up faltering economic growth is likely to have a much greater bearing on the market's trajectory in the second half of this year, given the view by some that its economy is on a razor's edge.
A prime source of that instability is China's volatile property market. The South China Morning Post reported that home prices in two-thirds of the largest Chinese cities increased in February, adding to fears that a new property bubble is forming in some large population centres; a point highlighted by property prices in Shenzhen, a source of previous market instability, which were up 57 per cent from a year earlier. Gains across other major metropolitan areas were muted by comparison, and somewhat patchy, but the overall 3.6 per cent growth rate recorded by China's National Bureau of Statistics still represents the fastest acceleration since June 2014.
The renewed interest in property investment comes on the heels of policy stimulus measures from Beijing, and the clamour for bricks and mortar has intensified as investors have become more risk averse following the rout in Chinese equity markets in the second half of last year; a problem compounded by a chronic shortage of alternative 'paper' investment options in the People's Republic.
Shadow banking and US sub-prime
More worryingly, one of Premier Li Keqiang's top economic advisers was reported as having drawn parallels between China's property market and the US sub-prime crisis. That's because Chinese home buyers are borrowing increasing amounts of money through the country's shadow banking system. In recent years, a plethora of real estate vendors, property development companies and peer-to-peer lenders have stepped into the market, with an all-too-familiar outcome whereby individuals with no assets, savings or a deposit can now access mortgage finance. There isn't the same systemic risk as with the US housing crisis as foreign institutions are not involved in the loans, and the size of these loans compared with the total amount is small, but the nature of the lending has some analysts worried.
Commodities rally down to short-covering
Some commentators have conflated the apparent pick-up in China's domestic construction activity with the rally in commodity prices through this year, although citing standard market levers in this case is probably disingenuous. The MSCI World Commodity Producers index is up by 22 per cent since midway through January, a reflection of short-covering as bearish bets on further commodity price declines were unwound by traders. And it may well be that commodity prices have bottomed-out, but any support through 2016 is largely attributable to a sustained sell-off in US dollar-denominated assets by The People's Bank of China. This has weighed on the value of the greenback, which exhibits a strong negative correlation to commodity prices. Short-term positioning is now more neutral so presumably we should witness a reduction in volatility with speculative positions largely expunged from the market.
