China property rally begins to wobble

HONG KONG Fri Jul 20, 2012 6:36am BST

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HONG KONG (Reuters) - This year's rally in stocks and bonds of mainland Chinese real estate developers looks set to peter out, analysts say, as valuations have become less attractive and hopes have dwindled for any roll back of steps taken to dampen home prices.

The tide appeared to start turning during the past week, though China's property sector remains among the best performers across Asia this year, easily outpacing benchmarks.

"The best performance for the China property sector is behind us and further gains will be difficult because of rich valuations and economic headwinds in the second half of 2012,' said Owen Gallimore, head of credit strategy at ANZ in Singapore.

"It is doubtful if people want to buy beyond the top-tier names and into the mid-tier after such a strong rally," he said.

An index of property shares in Shanghai .SSEP is up 17 percent this year in contrast to the Shanghai Composite .SSEC which has drifted into negative territory and is currently near the year's lows.

Valuations for the MSCI China real estate stock index have nearly doubled since the fourth quarter in 2011 when they hit a record low of just 4 times forward price-to-earnings.

According to Deutsche Bank, a weighted index of 45 bonds from 32 property companies produced a return of 25 percent in the first half of 2012, easily beating the 6.7 percent total return for the overall JP Morgan Asian Composite bond Index.

Some individual bonds have even beaten that. Shimao Properties' (0813.HK) bond prices maturing in 2017 rose 66 percent from the October lows.

A rebound in transactions mainly from first time home buyers came as a relief for the property sector earlier this year, lifting it out of the funk it had fallen into by the end of 2011.

According to Macquarie Capital Securities sales volumes in China's tier-1 and tier-2 cities on a four-week average basis bottomed out around February this year and have gathered pace after June.

But as house prices were still in decline through this period and there was growing unease over China's economic slowdown, hopes grew that Beijing would rethink measures taken in the past two years to cool off an overheating property market.

But now, with signs that home prices have bottomed out, the thinking is that Beijing is more likely to leave controls in place to forestall any rebound in home prices.

After data released on Wednesday showed that China home prices broke eight straight months of declines in June, shares in the property sector began retreating faster.

The Shanghai property sub-index slumped and at one point during the day was down more than 5 percent and has underperformed the broader market significantly.

Investors are worried over how the government would respond should sales volumes stay strong and prices begin rising.

"If strong sales continue for another six months it is very likely that the government faces a dilemma again," said William Fong, a fund manager at Baring Asset Management, adding that the government may have to come in with another round of curbs.

"After the rebound we've seen some investors might want to think ahead and position for that," said Fong, suggesting investors will withdraw from the sector if they suspect more measures to contain the property market are on the way.

BONDS IN SHORT SUPPLY

Even though second quarter GDP data met expectations for 7.6 percent growth, anecdotal evidence from cuts in steel prices by Baosteel, the country's biggest steelmaker, and falling electricity output suggest the economy may be decelerating more than realised.

For bonds, there is a risk that if the economy runs into strong headwinds, purchases by first-time home buyers could fade, reducing a precious source of funds for developers.

That could force developers to issue more bonds in the primary markets which could dampen investor appetite. Only three bonds have been issued so far this year compared to copious supplies during the previous two years.

One credit fund manager at a Hong Kong asset management firm said the lack of supply at a time when investors have piled into bond funds have pushed up market prices as trading desks simply didn't have the paper to satisfy growing demand.

"But if we see some of the early investors starting to take profits, it could trigger a selloff as macro concerns remain," he said.

(Additional reporting by Umesh Desai; Editing by Simon Cameron-Moore)

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