China's Evergrande Crisis: A Real Threat to U.S. Stocks?
A looming debt default by Chinese real estate titan Evergrande is sparking fears of global contagion and knocking stocks from their perches.
Many investors had probably never heard of Evergrande (EGRNY, $10.90) prior to Monday morning. But once the massive and massively indebted Chinese real estate company sparked a selloff sweeping from Asia through Europe and on to the U.S., anxious chatter about contagion and a potential global credit crisis seemed unavoidable.
Evergrande, you see, is facing a liquidity crisis. And it very well might default on coupon payments owed to foreign bondholders due in just a matter of days.
That could be just the beginning, the fearful thinking goes. After all, Evergrande's total pile of debt comes to $300 billion. A default or series of defaults could spread panic in credit markets well beyond China's shores.
Pessimists see these developments and say we've been here before – and not that long ago, either. A worst-case scenario, the bears contend, is that China lets Evergrande implode in a scenario similar to what befell Lehman Brothers almost exactly 13 years ago. The fall of the once-mighty Wall Street titan wreaked havoc on global markets and became a sort of ground zero for the Great Financial Crisis.
No wonder, then, that the S&P 500 was off as much as 2.9% at one point in the trading session, and the Dow Jones Industrial Average lost more than 600 points by the closing bell.
But market strategists for the most part argue that although Evergrande presents a threat, and uncertainty reigns supreme, a Lehman moment is a remote possibility. True, the Chinese government appears more likely to make an example of the company than to save it – but that hardly means global disaster is preordained.
Is Evergrande About to Be Another Lehman Brothers?
Evergrande isn't just enormous, but sprawling. Thus, its $300 billion of debt is just one area of concern.
The company is a property developer at its core but also has subsidiaries and investments in health, autos, sports, media and finance, among other ventures. To get a sense of its scope: Evergrande recorded $110 billion in sales last year; owns $355 billion worth of assets across 1,300 developments; employs 200,000 people; and hires 3.8 million workers every year for project developments.
In other words, Evergrande's woes have serious implications for China's economy in addition to its global creditors. But even the pessimists aren't ready to commit to the "L" word quite yet.
Over his long Wall Street career, David Rosenberg, chief economist and strategist at Rosenberg Research, has been known for his generally bearish take on markets and macroeconomics. He notes that Hong Kong-traded shares in Evergrande tumbled 19% Monday due to default concerns, and that its bonds are trading at 30% of face value.
"It feels like an ominous repeat of what happened when the Asian property bubble began to burst in the summer of 1997," Rosenberg writes in a note to clients. But he adds that "it may not exactly be a Lehman moment."
More positively, there's Dr. Ed Yardeni, president of Yardeni Research, who says Evergrande will more likely end in a restructuring similar to that of Long Term Capital Management in 1998, rather than a Lehman-type failure.
"Some fear a Evergrande meltdown will have systemic risks on par with the impact Lehman Brothers' demise had on the U.S. stock market," Yardeni writes "While we don't see the Chinese government saving Evergrande, we'd expect it will provide enough liquidity to make the company's retail creditors whole. Or at least we hope so."
The Global Macro Strategy team at UBS Global Research takes much the same view, with restructuring being more likely than collapse.
"While our base case is now that a credit event for Evergrande seems unavoidable, the extent to which we get spill over into other markets will be contingent on whether Evergrande restructures or fully liquidates," writes UBS strategist Kamil Amin. "As of today, we remain confident that the former is a much more probable outcome."
Amin advises clients to keep an eye on upcoming coupon payments on Evergrande's offshore bonds, "as this could be the trigger for a credit event." Payments are coming due on Sept. 23, Sept. 29 and Oct. 11, he notes.
Doug Peta, chief U.S. investment strategist at BCA Research, wouldn't be surprised if the Chinese government allows the situation to get much more intense – if not downright ugly. But an increasingly messy state of affairs needn't morph into catastrophe.
"Our China strategists believe that the government wants to make an example out of Evergrande to impose some discipline on investors and developers," Peta writes. "Some onshore investors may be bailed out, but party officials will have no qualms about leaving offshore investors holding the bag."
Importantly, however, brinkmanship does not equal bankruptcy.
"The bottom line is that we do not view Evergrande as China's Lehman," says Peta. "Policymakers may want to make an example of it but not to the point that they will stand by in the face of a broad contagion. The fall of an overextended Chinese property developer is unlikely to push the U.S. out of Goldilocks and into too-cold territory."
And as counterintuitive as it might sound, a Lehman-type event could ultimately help U.S. investors, the strategist adds.
"Even if it did produce a credit event that rippled across Asian EM markets and tempered investors' enthusiasm for risk assets, U.S. markets would benefit in a relative sense befitting the dollar's status as a defensive currency, Treasuries' status as the predominant risk-free asset and the S&P 500's low-beta nature," Peta says.
Just an Excuse to Sell?
Perhaps the most interesting observations come from strategists who say Evergrande isn't the real issue at all.
David Bahnsen, chief investment officer at The Bahnsen Group, for example, says Evergrande's bond prices have been collapsing for some time, it's troubles apparent to all. The company on Monday happened to become a convenient excuse to unload equities, rather than an actual cause.
"While the Evergrande situation is front and center, the reality is, stock market valuations are overstretched and the market has enjoyed too long of a break from volatility and stock market declines are not surprising," Bahnsen says. Indeed, in Yardeni Research's weekly look at stock-market fundamentals, the S&P 500's 20.8 forward price-to-earnings (P/E) multiple remained near levels last seen ahead of the dot-com crash. The index's price-to-sales (P/S) multiple of 2.8 is as high as it has been since data was first available in 2004.
"I don't see any systemic risk for the global economy, 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," Bahnsen adds.
Jamie Cox, managing partner for Harris Financial Group, concurs wholeheartedly. After all, investors have plenty on their plates at the moment. And that's apart from the fact that September is historically the worst month for market performance.
"The Evergrande situation, although big and impactful, isn't the reason for this selloff," Cox says. "Rather, stalemates in Congress on the debt ceiling, worries on policy changes or mistakes in monetary policy, and a litany of proposed tax increases have dampened the mood for investors.
"When this occurs, corrections happen."