A ‘contagion’ is rattling the markets and its ripple effects are being felt across the globe. When you live in a global village, the butterfly effects can be spotted easily but this is no butterfly. The ‘risk-on’ focus currently by the media is the real estate giant Evergrande in China that is effectively in default. This has been in discussion by the market for a few weeks. With over $300 billion in liabilities, there is speculation that it could melt the financial system in China. A sort of Lehman moment for China. However, such a free market sort of outcome is very unlikely in China. Here’s a UBS report explaining the implications.
Everything is not going that smoothly in China and if anything, nothing that they are doing is supportive of free markets. Over the last few months, the Chinese government has implemented a lot of regulatory ‘crack down’ across various industries in the name of ‘common prosperity’. All these new ideas have cleaned up nearly $1.5 trillion of Chinese stock valuations.
The Chinese government and PBOC are putting on a brave face and are even sounding to the public through their state media Global Times that Evergrande should not expect a bailout and it shouldn’t assume itself that they are “too big to fail.”
Evergrande is already down 10% in HK markets yesterday. The Chinese govt has given a support of $14 bio liquidity injection to its banking system but there is more to this story which I will cover in another piece.
What we need to understand is China is in a position of strength globally coming out of this pandemic and the Chinese government is nationalizing parts of the economy meaning taking more control. They can manufacture any type of outcomes that they want. Intervening and controlling outcomes is something that they really excel at.
But if you are looking for systemic risk, the bond markets is the first spot to reflect that. It is the safe haven for global capital in times of risk. While yields moved lower, it was relatively very muted and was only 5 basis points holding and closing above 1.30. So, investors around the world are not panicking. Participants are sanguine indeed!
The bigger issue for stocks at the moment is the change in policy direction the Fed can make tomorrow. The Fed has been preparing the markets for this for a long time and I have been saying that in my writings as well. Whatever the Fed does, you can be assured that monetary policy will remain extremely accommodating. Raising rates is still some time away. Meanwhile, the fiscal side stimulus is only getting more extreme. This combination should continue to fuel prices higher still.
In the broader markets, we already have a 5% decline. Markets have broken down below the clear uptrend almost at a 45 degree angle for the first time since Election day. Another move down to the 200 day moving average can also happen which will make it 10% down. This may happen very quickly and should be a buying opportunity. In a world that is flooded with so much liquidity and more to come, the history of the past 13 years have confirmed to us that the recoveries can be very fast as well. Eventually, the top will come but it may not be now. When that happens, nobody will ring a bell at the top.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.