For all the risks, healing in financial markets domestically and an increasingly durable economic recovery promise to contain any American correction and ultimately drive market prices farther upward. For emerging markets-where information is less transparent-chances of a major correction after the recent wild ride loom larger, especially in China, where policy has moved toward restraint.
Still, for the longer term, China remains attractive and there is little chance of the nation following in Japan's unfortunate footsteps, as so many recent popular scare stories have suggested.
Certainly, there is cause for concern about China. Market gains of more than 80% in 2009 occurred against a backdrop of massive fiscal stimulus and an explosion of debt-the root of America's wrenching 2008-2009 correction.
According to official figures, Beijing injected the equivalent of $575 billion into the economy starting late in 2008. At almost 15% of China's GDP, that push, in relative terms, dwarfed America's $787 billion stimulus, and amounted to less than 6% of the U.S. economy. Especially troubling was the fact that almost two-thirds of China's stimulus package came through loans. According to official data, these loans jumped by the equivalent of $1.4 trillion, a 30% gain over the year. Some suggest that lending by local governments brought the total closer to $1.7 trillion, in excess of 35% of China's gross domestic product.
Still more frightening in this context is China's residential real estate boom. Home-buying activity surged to 82% in 2009, and house prices rose 24% nationally. In places such as Shanghai, home prices rose during 2009 to a level that was 87% higher than the previous 2007 peak. Begging a correction, these price increases put the average Beijing apartment at 15 times the typical resident's annual income and national prices at 10 times the median annual household income. This is far above comparable ratios in the United States where home prices stand at about three and a half times the median annual household income.
Perhaps pointing the way for the residential market, the over-built commercial real estate market has already begun to show slight price declines.
Even as Beijing makes efforts to engineer what might be described as a soft landing, there is considerable fear that the real estate market-much like a house of cards-will collapse. Policymakers have raised bank deposit reserve requirements twice. The China Banking Regulatory Commission has ordered banks to curb lending generally and to follow "strict" standards in real estate lending. These orders carry weight since most Chinese banks belong to the state. Authorities also imposed a new tax on property sales that occur within five years of purchase, raised the required down payments on second and third homes to 50%, and imposed a 50% down payment requirement on new developments. Beijing also has insisted that local governments set aside at least 70% of the property under their jurisdiction for small residential units and state-subsidized housing. The People's Bank of China-the country's central bank- has clearly indicated its intention to raise interest rates later this year as a means to slow overall money growth to 15%, from 30% in 2009.
But even as China's stock market has given back some of its gains, there is little reason to fear that matters will collapse as expected, certainly not as Japan did 20 years ago or the United States in 2008. To be sure, Chinese stocks rose sharply in 2009, but only after a 70% plunge the previous year. Chinese equities are still less than half way back to their former peaks, and valuations are nowhere near the bubble status. While Chinese earnings were up smartly last year and are expected to rise at least 10% more this year on real GDP growth of 9.5%, current market prices equal about 21 times 2010 earnings. Though these are not levels that one would characterize as cheap, neither are they excessive in a fast-growing economy. They are a far cry from the Japanese multiples of 70 times earnings prior to that country's market collapse in the 1990s.
Further, the use of credit in China is not anything like Japan's or America's before their respective crashes. The Japanese and American booms were entirely credit-induced and had little basis in fundamentals. In China, leverage is a lot less prevalent. One-quarter of Chinese homebuyers pay cash, and, on average, mortgages cover only half the property's value. No one in China bought with less than 20% down. Household debt in China amounts to approximately 40% of household incomes-far below the United States, where it peaked at 130% of income. Though prices are high relative to incomes, many Chinese argue that household earnings are severely understated to avoid tax.