There is growing concern that China’s economy may be in some serious trouble. Macrolens Chief Strategist and Managing Principal Brian McCarthy says that, as is, China is dealing with geopolitical concerns and an economy in transition. With that backdrop, the country is also experiencing “the biggest housing bubble we’ve probably ever seen has just blown up,” which will be a drag on credit extensions and consumer confidence, McCarthy tells Yahoo Finance Live. “I’m sort of in the camp that China might be collapsing, actually,” McCarthy says, adding that the imploding of the property bubble may result in trillions of dollars of losses. McCarthy also cites demographic changes, the slowing economy, and a potential trade war with the U.S. as other issues weighing on growth.
BRAD SMITH: China’s stocks failed to hold on to most of their Monday gains as the latest effort to jumpstart the country’s economy fell flat. Several US sectors stand exposed to China’s failure to relaunch. How hard will they be hit? And what will it take for the world’s second largest economy to correct course? Joining me now with more, we’ve got Brian McCarthy, chief strategist and managing principal over at Macrolens. Great to have you here with us this morning, Brian. First and foremost, why has it struggled? What is this sputtering kind of derivative of from your perspective?
BRIAN MCCARTHY: Well, obviously, China is beset by a lot of geopolitical crosscurrents and risks on that front. They’re in a transition of their economic model away from credit-fueled growth to something they hope to be more value-added but is not going to involve any kind of market-based reform. And against that difficult backdrop, the biggest housing bubble we’ve probably ever seen has just blown up. So this is creating a massive drag on credit extension in the Chinese system.
It’s putting the system at great risk for debt deflation. And it’s going to have grave ramifications for consumer confidence and the growth level in the Chinese economy.
RACHELLE AKUFFO: And Brian, I think, a lot of times, when people look at the Chinese economy, they look back at that breakneck speed. China’s in a very different sort of growth pattern right now. But we seem to be in this phase narrative-wise of either China’s collapsing or China’s taking over the world. What are some of the important nuances that investors should keep in mind when they look at China’s growth and how it sort of trickles down to the US economy?
BRIAN MCCARTHY: Sure. So I’m sort of in the camp that China might be collapsing actually. So this property bubble, we’re talking potentially trillions of dollars in systemic losses. So we’ve gone from this situation where there are things, like you alluded to, China’s got demographic problems. China’s been slowing consistently and steadily for a number of years. The investment-led growth model was basically, they had to invest more and more money and lower and lower return infrastructure projects. And then they’re dealing with this sort of budding trade war over the last few years with the US.
So there are all kinds of structural problems that were weighing on Chinese growth. And I think the question now in the wake of the property bubble is, is this going to continue to be a gradual controlled slowdown? And I think that’s the market consensus, that Chinese growth might slow down 3% or something like that over the next three or four years. And in that scenario, the direct risks to the US are fairly limited.
But there is another scenario in which that proves to be an optimistic case. And this bursting of the property bubble elicits a sharper, harder-to-control slowdown in the Chinese economy where maybe their growth is negative next year, which I think is not an outrageous forecast. In that environment, you’ve probably got severe weakness on the RMB, which is then infecting other emerging market currencies.
And as we saw in 2015, 2016, that kind of activity can generate financial market feedback on the West, which can have serious ramifications. So in the controlled slowdown, we’re OK. But if it’s worse than that, there will be volatility in US markets.
BRAD SMITH: OK, and so just focusing in on what you were mentioning a moment ago and perhaps what is the worst of the bear case scenario in a negative growth environment for China, where do you see that impacting some of the other US companies, even, that have invested heavily into and have banked their own growth ambitions around success with the Chinese consumer and with the market, more generally in China?
BRIAN MCCARTHY: Yeah, I think we’re going to find that a lot of Western multinationals have bad growth forecasts in terms of Chinese consumption. Chinese households are sitting on somewhere between 65 and 80 million empty apartments. That’s about $10 trillion worth of real estate that’s sitting there empty. And now, we’re seeing declines in Chinese real estate of, by some reports, 20% to 25%. This is going to get worse.
So you take a third of the value of the $10 trillion empty apartments, that’s $3 trillion in wealth evaporating amongst Chinese consumers, particularly in the high wealth cohort. So pretty severe effects potentially for companies that sell luxury goods to Chinese consumers. But I think that the Chinese consumption story, again, just a lot of companies are going to be stuck with bad forecasts there because the Chinese consumer, I think, is going to remain under a lot of stress in the next few years.
RACHELLE AKUFFO: And so Brian, obviously, very interconnected economies here. Which US industries then would be the most exposed if there was suddenly a sharp negative downturn in China?
BRIAN MCCARTHY: You know, it’s companies that do a lot of business in China, like Starbucks has had good numbers because they have had a bit of a reopening boost to service sector activity in China. That has happened. It’s just been swamped by other negative effects, mainly emanating from the property sector. But Nike, again, any consumer goods makers– I’m sorry, luxury goods providers to China are just going to continue to see, I think, disappointing revenue numbers out of that market.
RACHELLE AKUFFO: Especially when you have a nation of savers, any sort of economic downturn, everyone will sort of clutch the purse strings ever tighter. We do appreciate you joining us this morning. Brian McCarthy, chief strategist and managing principal at Macrolens. Thank you so much.
BRIAN MCCARTHY: Thank you.