Markets rally as Evergrande approaches default: it’s like an ‘old-fashioned sniff of glue’
Why are investors so relaxed right now?
Last Monday, the Australian stock market had its worst trading day since February.
Chinese real estate giant Evergrande was feared to explode, with debts totaling more than $ 400 billion, and cause an economic crisis in the world’s second-largest economy.
However, by Friday the market had recovered most of its losses.
It doesn’t matter that Evergrande didn’t fix his debt problems, or that he missed a coupon payment to bondholders on Thursday.
The markets even rallied on Thursday.
So what is going on?
The big relaunch!
Michael Every, Rabobank’s global strategist, asked himself the same question on Friday.
In his daily note, he put Evergrande’s situation on a long list of other events that you think would be detrimental optimism, but which are not.
Apparently, the “stimulus trade” momentum – which has driven global equity markets up since the 2020 lockdowns ended – is still too powerful.
Real estate prices are skyrocketing around the world. Supply chains are under intense pressure. Labor markets are not in the best condition. The virus is still ravaging some economies.
But the stock markets are still boiling.
“As we all know, markets can stay irrational longer than you can stay solvent, and they are encouraged to do so when monetary and fiscal authorities encourage them to sniff solvency,” Every wrote on Friday.
“However, the ‘reflation! Yesterday! trade appears to be sniffing old-fashioned glue without any help from central banks or governments. “
He said that as a group of central banks began to talk about gradually raising interest rates and cutting their bond purchases, the People’s Bank of China (PBOC) was playing the “usual game” last week. with net injections of cash like the wall The Street Journal reported that local Chinese governments have been ordered to prepare for the failure of Evergrande.
Would this news have been enough to scare investors? Apparently not.
“This is seen as bullish by some because it means China is proactive,” Every wrote.
“Here again, the company is ‘saved’ by being split into three and nationalized, another story that circulates, which involves losses for holders of bonds and shares, and a new economic model.
“We know the supposed answer, but do we know the unintended impact on the exchange rate? It’s not reflationary – at least outside of China.”
He also questioned the lack of information from China on Thursday regarding Evergrande’s creditworthiness.
Was the silence a worrying sign? Apparently not.
“No one appears to own Evergrande foreign debt which could now be in default after missing a coupon yesterday and starting a 30-day grace period countdown. Anybody. The company clearly sold all of these bonds, ”he wrote.
“And Chinese dollar bond issuers rated as garbage were already back in the market yesterday as ‘Evergrande to fail’ stock grabbed the headlines even real estate developers rated for garbage.”
So, are the markets just getting a short-term respite before reality hits?
A little calm required
At the end of Mr. Every sardonic note, you get the feeling that we should all get attached.
However, AMP Capital’s chief investment officer, Shane Oliver, in his weekly market review on Friday, said that while short-term correction risks remained, a disorderly default and liquidation of Evergrande were unlikely.
While the Chinese authorities “want to teach real estate developers and investors a lesson” about the dangers of excessive debt, he said, it is “very unlikely” that they will allow the failure of Evergrande to turn into a major credit crunch that would result in other real estate developers. and ultimately collapse the real estate sector and the economy.
He listed four reasons why a disorderly default was unlikely:
- The Chinese government cannot allow a collapse in house prices as it would destroy much of Chinese household wealth
- Chinese economy and real estate collapse following pandemic could trigger resurgence of social unrest
- A collapse in housing construction would run counter to the government’s desire to make housing more affordable
- Chinese authorities have seen the damage that occurred after Lehman Brothers was allowed to go bankrupt in the global financial crisis, and they “will have learned the lessons.”
Dr Oliver said the “resolution” of Evergrande’s debt payments due Thursday last week, and the relative calm in China’s own debt markets thereafter, were “possible signs” that authorities were working on a restructuring.
In any case, it was enough to see Evergrande’s fears fade by the weekend.
A little more perspective
Earlier last week, analysts at Barclays in Hong Kong were among the crowd saying that Evergrande’s problems are unlikely to turn into a Lehman-style event.
They said Chinese authorities have been monitoring the Evergrande situation and have been doing so for months.
The banking system’s exposure to the real estate sector, they said, has been steadily declining since the Chinese government’s deleveraging campaign five years ago, with loans to the real estate sector falling from 37% in 2016 to 26% in 2021.
Instead, they said, the risks were higher due to a correction in house prices spilling over to other sectors of the Chinese economy.
Reuters reported that Evergrande had 800 projects under construction. Of these, 500 have been put on hold and another 300 projects are at risk of being put on hold due to lack of funds to pay suppliers and workers.
According to analysts at Barclays, the baseline scenario of what could happen in China was for a visible slowdown in the housing market over the next two quarters, with real estate investment slowing to around 0%.
And, given the weakening of investment, there could be spillover effects in other sectors.
“We believe that steel, cement and other building materials would be affected by the cooling of the Chinese real estate sector,” they said.
“Along with China, the construction sector directly accounts for almost half of all steel consumption.
“We expect spillover effects on raw material imports, as the real estate sector – as well as infrastructure investments – consumes a large part of imported raw materials.
“Major commodity imports – like iron ore, copper – have weakened this year after peaking in mid-2020.
Should investors stay calm?
However, looking at the larger world situation last week, Mr Every was not really convinced the authorities had a grip on things.
After looking at the problems of global supply chains and the number of central bank money impressions around the world, he wondered if anyone was properly assessing risk or if investors were fond of adhesives.
“When supply chains were collapsing and the job market wasn’t doing as much work.
“It takes a LOT of glue to hold this kind of number together, trust me, ”he concluded.
He could have said the same about the Australian real estate market.