< Back to 68k.news US front page

What The China Evergrande Crisis Means For You

Original source (on modern site) | Article images: [1]

Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations.

Six months ago, investors panicked when the container ship Ever Given got stuck in the Suez Canal, clogging global energy markets and international trade. Today, markets are fretting over a potential default by Evergrande, a highly indebted Chinese real estate behemoth, an event that some believe could set off a global financial panic.

While the Ever Given fiasco was a mere blip on route to an otherwise stellar first eight months of 2021 for markets, stocks have endured a rough September as fears grow that Evergrande's demise could cascade into a protracted debacle that might slow the world's second largest economy. Add in the continuing gain in Covid-19 cases from delta, higher inflation and the Federal Reserve signaling it will buy fewer bonds in the months to come, and you begin to see why market participants have been shocked out of complacency.

The question you need to ask yourself is whether the Evergrande experience will resemble Ever Given—quickly forgotten—or perhaps something more serious, such as the 1998 Long-Term Capital Management (LTCM) imbroglio, in which an overleveraged hedge fund was bailed out by the federal government to prevent enormous market turmoil if it failed to pay its debts.

So far, experts believe it's the former.

"On a down market day, it's easy to look to the nearest headline like Evergrande and attach a cause and effect, but this market has experienced almost no downside volatility for a long time and a pullback was long overdue," said David Bahnsen, chief investment officer at The Bahnsen Group. "Evergrande's collapsing bond prices have been forecasting its challenges for some time."

What's Going on With China's Evergrande?

One thing's for sure, China Evergrande Group is in big trouble.

The real estate giant, which also is active in electric automobiles, wealth management, theme parks and even a soccer team, has already be unable to meet obligations on some of its nearly $90 billion in debt, along with another $300 billion in liabilities, causing it to restructure obligations with its creditors. This has understandably caused chaos and confusion in China since Evergrande is the nation's largest junk bond issuer.

This crisis was precipitated by the Chinese government's decision to reduce the amount of debt companies could take on. This caused a capital crunch for Evergrande, forcing it to suspend construction of new apartment buildings and delay payments to suppliers.

The firm's customers and business partners aren't happy. Folks who've handed over the equivalent of hundreds of thousands of dollars want their homes built, investors want their principal returned and suppliers want to get paid. After all, if they don't receive what's owed by Evergrande, they can't pay their employees, who will then not be able to meet their own financial obligations.

If you lived through the 2007 housing crash, this might all sound familiar…and terrifying. A hot housing market goes pop, bringing down overleveraged conglomerates who don't have enough cash to pay their debtors, thus causing a financial panic to spread. And so far, it doesn't appear as if the Chinese government is eager to step in. In fact, recent reports suggest China may be willing to let Evergrande fail.

Given its history, though, be prepared for anything.

"China's market is opaque and unpredictable and the stock market doesn't react well to those characteristics, which is one reason why [the recent] selloff was so dramatic," said George Ball, chairman of Houston-based investment firm Sanders Morris Harris. "We know so little about China's economy and its inner workings."

How the Evergrande Crisis Is Punishing Global Stocks

Evergrande's problems have coincided with waning investor appetite for stocks: The S&P 500 fell 5.2% between Sept. 2 and 20. But Evergrande isn't the only source of stress.

Economic indicators, for instance, have been going sideways recently. Employers added just 235,000 workers in August, well below market expectations. Retail sales have jumped around while consumer confidence dropped to a six-month low.

Rising inflation continues, and the Federal Reserve hinted it will soon announce that it will begin to buy fewer bonds. This so-called tapering, while not as important as raising interest rates, does signal that the Fed is inching away from its emergency policy of pumping in a lot of easy money to help the economy recover from Covid fallout.

And then there's Washington. Not only is Congress debating a hotly contested $3.5 trillion social program bill, in addition to the $1 trillion infrastructure plan, but it'll soon need to raise the debt limit, lest the U.S. Treasury default on its debts. With Democrats fully in control of the nation's legislative and executive branches, Republicans are refusing to help.

Should the economy slow, and absent fresh economic stimulus, one Morgan Stanley analyst warns that stocks could drop 20%.

The anxiety over what may come is driving much of the pessimism.

"As of right now, I don't see any systemic risk for the global economy from the Evergrande situation, but there doesn't need to be any systemic risk in order for markets to be affected because there isn't enough clarity on how Evergrande's challenges may affect the global economy and that uncertainty is enough to spook markets," said Bahnsen

What You Should Do About Evergrande

So you should sell, right? Not so fast.

As Bloomberg's Brian Chappatta pointed out, increased agita over falling stock prices and a potential market correction could motivate people to engage in more trading activity, which could help the bottom lines of the same investment banks who claim a bear market is nigh.

Also, the recent turbulence appears stranger because thus far in 2021 stocks have steadily risen.

"After a relatively quiet summer where the path of least resistance for equities was steadily higher it seems as though market participants are looking to fade this year's rally," said Brian Price, head of investment management at Commonwealth Financial Network. "We are entering a period that has been historically choppy for the stock market and it seems that 2021 is not going to be an exception."

Which is to say, the current dip feels worse because stocks have performed so well recently. But when it comes to investing, the occasional down market is all part of the bargain.

And it's generally a good deal for long-term investors. While the period between 2019 and 2021 was filled with an avalanche of major news events—the Chinese/American trade war, a global pandemic and unprecedented stimulus bills—stocks have performed remarkably well. The S&P 500 gained 29% in 2019, 16% in 2020 and 18% so far in 2021.

In March it was Ever Given, now it's Evergrande and who knows what fresh crisis will strike in the months to come. Investors, though, do well by reading and understanding the news, just not trading off it.

< Back to 68k.news US front page