The key risk to China's economy—It's housing, not stocks

September 24, 2015


Part of Vanguard's Global Macro Matters research series

Understanding the current—and potentially future—state of the global economy helps investors put market movements into context. To promote that understanding, researchers from Vanguard Investment Strategy Group examine the economic trends that affect the investing environment in this new series. Below is their latest insights into Global Macro Matters.

The stock market isn't most concerning

Much of the recent volatility in China's stock market stems from renewed concerns about an economic hard landing (growth below 4%). In our view, a hard-landing scenario is less worrisome than an outright recession (negative growth). The probability of a recession is not trivial, because of the long-term and structural nature of the slowdown. Given this, we expect that China will marginally miss its stated 2015 growth target of 7%.

This is a pivotal time for the country as it transitions from a manufacturing-based economy to a service-based one. As such, concerns over China's economy should persist for years. Policy actions that address economic fundamentals should be more effective—and welcomed by long-term investors—than ones that react to stock market activity.

Housing is a bigger economic risk

Despite elevated volatility in China's stock market, only about 9% of household wealth is invested in equities, versus 36% in the United States. The real estate market, on the other hand, is the largest single source of Chinese household wealth. Home values across China have risen 279% since 2002 and, by some measures, seem inflated in more than a few cities, as illustrated by a 457% home-value increase in Shanghai. For China to improve its economic outlook, the housing market needs to stabilize.

The housing decline explains 75% of China's slowdown since 2008

Housing has been essential to China's growth, growing an average of 25% per year from 2003 to 2013; it now represents about 10% of GDP. In comparison, U.S. housing construction peaked at 6% of GDP in 2006. Our calculations show that China's housing market alone accounts for nearly a quarter of the world's demand for aluminum, steel, and zinc.

Based on our analysis, a 10% decline in housing investment sheds more than 2% from headline GDP growth. Despite housing's impact, it is unlikely to trigger a U.S.-style home-price collapse because China's property market is much less leveraged than in many developed economies. The ratio of mortgage debt to property assets is less than 7%, and Chinese buyers need a 30% down payment for a first-time mortgage and up to 60% for a second one.1

Despite China's size, a hard landing is not enough to trigger a global recession

A slowdown in China's real estate investment is expected, but the likelihood of a housing market crash that leads to a global recession is low. China's slowdown will be most felt by its neighbors and commodity exporters like Brazil. There is a risk that select emerging-market economies will continue to struggle in adjusting their growth models given low commodity prices, weaker productivity, and high debt levels.

Our view remains that China's slowdown and excess capacity will generate deflationary impulses worldwide, and investors should expect periodic and sharp volatility. However, that volatility should not damage global growth too significantly as long as the United States and Europe continue recovering and China avoids a housing market crash.

1 See the Global Macro Matters paper China: Slowdown Possible, Financial Crisis Less So, at


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