- Sept. 28, 2021
-- With no shortage of headlines to worry about, volatility made a comeback last week after being dormant for most of the past six months. The financial troubles of a large Chinese property developer added another brick to the proverbial wall of worry, which includes growth slowdown concerns, inflation pressures, a dial down of central-bank stimulus, and the debt ceiling. This growing number of uncertainties resulted in the biggest daily S&P 500 loss since May, before stocks rebounded as the week progressed1
. We view last week's brief stock-market rout as a temporary and not completely unexpected setback within the confines of an ongoing bull market. We'd offer the following perspectives.Evergrande's debt woes unsettled global markets, but contagion risk likely limited
As China worries intensify, will a policy pivot follow?
- The potential default of the indebted Chinese property developer Evergrande was the catalyst for the S&P 500's first 5% pullback (based on intraday prices) in almost a year1. With a $300 billion debt load, an amount equivalent to around 2% of China's GDP, and $100 billion of real estate sales last year, Evergrande's size triggered fears of financial contagion at a time when growth in the world's second-largest economy is decelerating2.
- An announcement that the company settled its domestic bond payment later in the week sparked a relief rally, but questions remain about interest payments on dollar-denominated bonds and the way a potential debt restructuring will look. Nevertheless, the direct exposure to Evergrande's debt owned by non-Chinese creditors and investors does not appear large enough to threaten the financial stability of the global banking system. To this point, a slew of banks, including Credit Suisse, which underwrote the most Evergrande bonds among international banks in the last 10 years, have issued statements emphasizing their limited direct exposure to the property developer.
Sources: 1. FactSet, 2. Bloomberg
- A possible softening of the housing market adds another headwind to Chinese economic growth, which has been weakened by restrictions to curb renewed outbreaks of COVID-19 cases, a slowdown in credit growth, and a regulatory crackdown across a wide variety of sectors. We think that, as has happened over the past decade (namely in 2011/2012, 2015, and 2018), the crisis of confidence will trigger additional steps by policymakers to relax policy and ease liquidity to help growth.
- The fact that Chinese equities did not reach a new 52-week low last week, and that the emerging-market benchmark kept pace with the S&P 500 despite the gloomy headlines, is a sign that a lot of bad news is possibly priced in, and that a policy stimulus is expected.