Housekeeping
Like always, it goes without saying that nothing that I write in these posts is intended to be or shall be constituted as financial advice. Also, the opinions here are solely my own and they don’t reflect the opinion of any company I might be affiliated with. I don’t promote anything for money anyway.
Macro: What a Mess
I have to say however, even with the global economic slowdown and Evergrande’s bankruptcy, the probable reason for the correction was the Fed all but announcing a taper. It’s coming. And so are rate hikes…eventually. Central banks around the world are increasingly hiking rates.
Inflation is the big boogeyman at the moment, and many countries can’t afford to let it run out of control. The main concern is that the current supply chain issues will lead to inflation not being transitory*. Back in June both the Fed and the market were expecting these inflationary pressures to be transitory, meaning they would ease after a few months. Both US government bond yields and the US dollar seem to show that the market expects inflation to force the Fed’s hand, and that they will hike interest rates sooner than previously expected:
But, being sensible, US equity indices are barely down in the past month. Also, to be honest, I wrote before how I was expecting a larger correction given the fact that all of the factors above are accumulating during a year when the S&P 500 hasn’t had a correction larger than 6%. Guess what? It still hasn’t. The tech-heavy Nasdaq 100 has obviously underperformed, given that tech stocks are more sensitive to interest rate changes, especially to sharp changes.
Higher-growth tech stocks have taken a harder beating this past month, for the same reasons:
I would write about the situation with the debt ceiling in the US also acting as a risk**, helping push yields higher (pricing a possibility of default), but in all seriousness the debt ceiling is always a non-issue. The US won’t default on its debt (God, I really hope I don’t regret writing this).
In any case, if we zoom out it’s clear that yields are low even within their 40-year downtrend, so it would be foolish not to expect at least some normalization in the medium-term, especially with inflation putting strong pressure on the Fed:
Only time will tell if the Fed’s decision to withdraw stimulus in the face of a global economic slowdown will prove to be a sound one. I’m pretending that sound monetary policy wasn’t abandoned years ago.
About that economic slowdown, China is still going through its deleveraging effort, now accelerated even further due to Evergrande’s bankruptcy.
China Services PMI:
China Manufacturing PMI:
China Retail Sales:
It’s hard for me to see a strong recovery in the Chinese consumer with the property sector beaten down so hard.
I don’t believe Evergrande is a global systemic risk. Out of its >$300 billion USD in liabilities only ~$18 billion USD are actually denominated in US dollars, the rest is in Chinese yuan. Evergrande is NOT the same as Lehman Brothers. Lehman was entangled in a complex web of financial derivatives and risky products which put other financial institutions on the hook and led to fast contagion. Evergrande does not. Also, a balance sheet has two sides, and Evergrande has many real assets they can continue to sell to at least have an orderly bankruptcy. It will still be a big hit for China, especially for consumer demand due to the sheer level of personal wealth tied to real estate, but in my educated and ignorant opinion it won’t lead to a global financial crisis.
Best work you can read on Evergrande is from Macrodesiac, and they were talking about it back in 2019…
Anyway, I believe the indicator to observe moving forward is China’s credit impulse, which I’ve mentioned before. The CCP has injected some liquidity already, but it will be curious to see how they balance their desire to deleverage the economy with their attempt to cushion the blow from EG’s bankruptcy.
My Outlook: if the Fed continues to signal more hawkishness then I do see the market correcting further, but in an orderly fashion, not a panic sale like during March 2020. I get the feeling some investors still believe the Fed will not end up withdrawing stimulus. I would also expect normal behavior, with sectors like energy & financials performing relatively well and high-growth tech underperforming significantly. China is more of a question mark in the short-term, but I do see them getting through this situation relatively ok (relative to the GFC in the US mind you).