The Americans are back. They bought $1.3 billion of Chinese dollar notes last quarter, up from just $23 million in the previous three months, Carrie Hong and Annie Lee at Bloomberg News reported Friday.
Junk debt can have a seductive beauty for traders who time the cycle right. U.S. investors who braved the high-yield rout in February 2016 – caused by the slump in oil to $26 a barrel – would have done handsomely by year-end.
It’s not hard to appreciate why they are seeing value in the region. Defaults have been weighing on the minds of Asian investors, driving down prices at a time when American high-yield bonds have done relatively well. The low-hanging fruit has already been picked in U.S. markets.
One can’t tiptoe into Asia’s junk territory without forming a positive view of China’s real estate developers, which dominate the asset class. After this year’s selloff, it’s possible to find some silver linings.
First, interest rates. While rising borrowing costs have been the prime concern for U.S. bonds, traders are now betting the Federal Reserve won’t raise rates at all in 2020 – in fact, they’re giving slightly better odds that the central bank will ease. The rationale is simple: President Donald Trump’s tax cuts can buffer the U.S. economy from the effects of his trade war for only so long.
What this means is that heavily indebted companies are likely to come out on top as long as they don’t have any major refinancing needs this year or in 2019. Of the 16 listed Chinese developers tracked by UBS Group AG, only Guangzhou R&F Properties Co. looks like it may face difficulties.
Second, a weakening yuan isn’t the vulnerability it might appear to be. Developers earn revenue in the Chinese currency, so a drop in the yuan – which depreciated 4.3 percent against the greenback in the past month alone – erodes their ability to service dollar debt. But most Chinese property companies still borrow mostly in their home currency.
Of 45 developers tracked by UBS, 26 have less than 30 percent of their debt in foreign currencies, while a further 15 are within the 30 to 50 percent range. Only four firms have foreign debt exceeding 50 percent of the total.
Third, China looks to be scaling back its campaign to rein in debt, reducing the threat of an onshore liquidity squeeze. Trump has muddied the waters with his trade fight. Beijing is quietly shifting away from debt control to focus on growth again, the Wall Street Journal reported on Friday. The June 24 reserve ratio cut by China’s central bank, following a stock market rout, also points to a lessening of the emphasis on deleveraging.
Last but not the least, don’t forget the structural change in China’s real estate market. The top 10 property firms will increase their market share to 35 percent this year, from 20 percent in 2016, Citi Research estimates. That’s good for property bonds – developers with access to the dollar bond market also tend to be the larger ones.
It’s dangerous trying to catch a falling knife. But the returns can sometimes make the risk worthwhile.