China property bonds soar on bailout trade

Prices for bonds of China's heavily indebted — and financially wobbly — homebuilders have soared in recent weeks.

Why it matters: The rally — spotlighted by the Wall Street Journal — suggests investors think China's economic troubles are so great that the government has no choice but to keep supporting key players in the residential real estate market.

• From the traders' perspective, that means bonds of companies that were near bankruptcy will keep making payments to investors. Therefore that paper — recently considered nearly worthless — is quite valuable again.

Flashback: In the fall of 2021, China Evergrande, one of the country's largest housing developers, started running short of cash to pay creditors, setting off a financial crisis among other real estate developers amid a downturn in the housing market.

• The fact that the government ultimately allowed Evergrande to default raised questions among investors, some of whom presumed these companies had implicit backing from the government.
• They then dumped bonds of Chinese homebuilders, in droves.

The big picture: Homebuilding — and related industries — accounts for between 25% and 30% of China's GDP, analysts have recently estimated.

• With China's important trade and export sector severely fouled up because of COVID-related lockdowns and growing tensions over trade with the West, it's imperative that the domestic housing sector doesn't completely implode if China is to deliver economic growth.

• That's why China's banks — which largely operate as an arm of the government — announced a major bailout package for the sector last month.

The bottom line: A longstanding tactic among traders worldwide is to buy what governments are bailing out. That trade is clearly working here.

• Returns on an index of Chinese junk bonds — a category dominated by developers — were roughly 29% over the last month, according to ICE Data Services.