Editors’ Note: MarketMinder Europe does not make individual security recommendations. The below merely represents a broader theme we wish to highlight.
Here is a tidbit so run-of-the-mill it seemingly shouldn’t merit mention: Global equity markets rose 0.7% in price terms last week.[i] Perhaps this seems typical, even boring. But in our experience, typical, boring weeks don’t start with markets falling -1.1% amidst warnings that a too-big-to-fail Chinese property developer is about to miss big debt payments (i.e., default), allegedly sparking a financial crisis in China and sending shockwaves globally.[ii] That was the general tenor of the financial commentary we encountered last Monday. Now here we are one week later, and the events we saw so many warnings about actually came closer to happening—yet markets seemingly shrugged it off. In our view, this is the latest example of the dangers of reacting to negative headlines.
At last week’s outset, financial commentators globally argued the world was on the precipice and that a default by Evergrande—a massive Chinese property developer—would cause a financial crisis in mainland China, potentially wrecking markets globally. We saw some analysts cite pure financial risks, via developed-world banks’ potential exposure to Evergrande’s roughly $300 billion (£219.9 billion) in debt.[iii] Others warned the company’s collapse would implode Chinese real estate markets, spurring a sharp economic downturn. When the company announced on Wednesday it had reached an agreement to pay the roughly $36 million (£26.4 million) in interest owed to onshore investors, the general reaction from commentators we follow was, yah but just wait for that $84 million (£61.6 million) payment due to overseas investors on dollar-denominated debt Thursday.[iv] Meanwhile, according to several reports, the central government indicated it had no plans to bail out the company and directed local governments to step in with targeted support for local businesses and homeowners only if absolutely necessary to prevent protests and other disorder.[v]
Thursday’s deadline came and went without a peep from Evergrande, and overseas investors didn’t see a penny of that $84 million.[vi] Evergrande isn’t yet in default officially, as there is a 30-day grace period, but the securities in question are trading as if default is a foregone conclusion.[vii] Meanwhile, Beijing signalled support for the millions of people who have bought unfinished homes from Evergrande, reportedly ordering local governments to provide cash for construction as needed whilst ensuring the company can’t divert the money to debt service.[viii] Although we have seen are no official policy pronouncements as of yet, in our view, actions reported thus far imply the government is focused on making residents whole whilst letting market forces play out for overseas investors. Time will tell how they treat domestic investors in the event Evergrande misses a local payment. There is precedent for making investors whole whilst letting companies suffer the consequences of default, as the government did when solar panel manufacturer Chaori Solar defaulted in 2014, but there is no consistent blueprint.[ix]
At any rate, we think it is fair to say that the chain of events pundits feared would happen largely played out: A missed interest payment and no official bailout. And yet, markets didn’t crater. After Monday’s decline, the MSCI World Index rose the next four days, more than erasing the initial drop.[x] From our vantage point, it looks like equity markets just sort of sighed in response to the missed payment. We don’t think it is wise to read too much into short-term moves, but we do think that if this missed payment was the trigger for an economic collapse and financial crisis, global equity markets probably would have registered it.
Instead, we got what we think is a classic reaction to false alarms: a selloff as negative headlines panicked investors, followed by a quick recovery as people seemingly realised a crisis wasn’t at hand. The news coverage also became more measured as the week rolled on, with many commentators (rightly, in our view), pointing out that China’s financial system was too walled off from the rest of the world for troubles there to ripple globally even if Evergrande were a huge mainland negative after all. Cooler heads prevailed with time, as we have found they often do.
Let this be a lesson: Reacting to fear and big short-term drops is quite likely to be an error, not least because markets are forward-looking and efficient, in our view. By the time Thursday’s missed payment made headline news, we think markets had probably already priced it in thanks to all of this week’s chatter. Our research shows surprises move markets, and after the early-week shouting and volatility, there was likely no surprise power left. We think markets are probably already looking past the 30-day grace period to the upcoming scheduled interest payments and pricing in the seemingly high likelihood of more missed payments. Without the surprise factor, this likely fades into the long-term backdrop, as our research finds such company-specific things usually do.
Whilst it remains to be seen exactly how the Evergrande saga will play out, we think there is a potential silver lining: the chance for the world to see a large company can fail in China without causing economic catastrophe. China has only recently begun allowing private firms to default, and Evergrande is the biggest test of that resolve. If the government lets it disintegrate and the economy doesn’t crash, that might help investors gain confidence and move on.
[i] Source: FactSet, as of 27/9/2021. MSCI World Index price return in GBP, 17/9/2021 – 24/9/2021.
[ii] Ibid. MSCI World Index price return in GBP on 20/9/2021.
[iii] “China’s Embattled Developer Evergrande Is on the Brink of Default. Here’s Why It Matters,” Weizhen Tan, CNBC, 16/9/2021.
[iv] “China Evergrande Unit Will Make Onshore Bond Coupon Payments on Sept 23,” Staff, Reuters, 21/2/2021.
[v] “China Asks Local Officials to Prepare for ‘Possible Storm’ if Evergrande Fails, WSJ Says,” Jesse Pound, CNBC, 23/9/2021.
[vi] “Evergrande Misses Payment Deadline, EV Unit Warns of Cash Crunch,” Anshuman Daga, Andrew Galbraith and Tom Westbrook, Reuters, 23/9/2021. Accessed via Yahoo! Finance.
[vii] “Evergrande Moment of Truth Arrives With Bond Payment Deadlines,” Rebecca Choong Wilkins, Bloomberg, 18/9/2021. Accessed via Yahoo! Finance.
[viii] “China Oversees Evergrande Accounts to Ensure Housing Gets Built,” Staff, Bloomberg, 24/9/2021. Accessed via Yahoo! Finance.
[ix] “Chaori Bailout Shows Beijing’s Desire to Protect Bond Market,” Charlie Zhu and Umesh Desai, Reuters, 9/10/2014.
[x] Ibid. Statement based on MSCI World Index price returns in GBP on 21/9/2021, 22/9/2021, 23/9/2021 and 24/9/2021.
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