Sunday, January 16

Evergrande crisis traps stocks with few ties to China

A struggling Chinese owner, and before long the shares of US auction and social media companies are falling. The chain reaction may say more about the extreme altitude of global risk assets than it does about economic contagion.

While it doesn’t take excessive research to understand why bank stocks and commodities are shaking in the vortex surrounding Evergrande, the link to a stock like Twitter Inc. or EBay Inc. is harder to see.


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“You have a whole basket of things to worry about, if you add this headline to the mix, everything will go awry. So there will be irrational risk reduction that is not logically connected, ”Art Hogan, chief strategist at National Securities, said of the Evergrande crisis. “Does it make sense that tech stocks are selling? No, but in a risk-free scenario, everything tends to be for sale, even cryptocurrencies. ”

While there may not be an obvious connection between some US tech stocks and China, that doesn’t mean the sell off doesn’t make sense. Soaring valuations have been bear food for months, and the Federal Reserve hawks are circling. Evergrande may seem like a flimsy foundation, but Monday’s loss is similar in size to half a dozen other market declines in 2021 that required no news to ignite.

In fact, investors took the opportunity to sell in a market that is perfectly priced. The Russell 2000 index of smaller companies, typically considered more US-oriented and with less international exposure than the S&P 500, led the declines, falling as much as 3.6% on Monday. An index of regional banks, packed with companies like Bank of Hawaii Corp. and PacWest Bancorp, lost 3.9% at one point.

The iShares MSCI Emerging Markets ex China ETF fell more than 2%, while Twitter, which is not directly accessible in the country, lost more than 4% at one point. And companies that only operate in the US, like the supermarket chain Kroger Co., also fell.

In other words, a lot of assets are getting involved in the liquidation, and “I don’t know if that’s entirely appropriate,” Hogan said.

Still, the word “contagion” is spreading due to Evergrande’s size. The Chinese real estate developer has liabilities worth about $ 300 billion, more than any other real estate developer in the world, Bloomberg reported, and accounts for about 16% of outstanding notes in the high-yield dollar bond market of China. Although concerns about the company’s ability to pay its debt have been creeping in for weeks, those concerns were more focused this week with about $ 83.5 million in interest on a five-year dollar bond due Thursday for the month. company.

But investors are also grappling with many other concerns: weakening earnings forecasts, a slow change in policy from the Federal Reserve, uncertainty in Washington DC, and more.

“With the high valuations, the Fed meeting tomorrow, we have a perfect storm for a very difficult day today,” said Katy Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group, in an interview on Bloomberg Television with Jonathan. Ferro. “For us, it is much more of an underlying problem that is much more economic and pervasive in nature rather than simply financial.”

Not all of Monday’s falls were without reason. A Goldman Sachs basket of Russell 1000 companies with the highest exposure to sales in China fell as much as 3.3% during the session, its worst day since mid-May, while another focused on stocks that are heavily exposed to supply chains in the country. bank-tracked – fell 3.7% at its worst.

Jerry Braakman, chief investment officer at First American Trust in Santa Ana, California, said it also makes sense for commodities like copper, iron ore and crude oil to decline.

“China is still a big driver of demand for commodities because they do all the manufacturing for us,” he said. Braakman also highlighted some of the tech giants, including Apple Inc. and Tesla Inc., with huge exposure in China. Apple in 2020 reserved about 15% of its revenue in China, a figure that reached 21% for Tesla, according to data compiled by Bloomberg.

For Gene Tannuzzo, portfolio manager at Columbia Threadneedle, it stands to reason that names tied to China’s real estate and related commodities will be hit, so he and his team are watching iron ore prices drop. “If other commodities follow it down (oil, copper), that generally correlates with weaker returns for the US high yield,” with the latter still suggesting that the risk of contagion is low, he said. “Everything is a little smoother today, but none of those charts look like iron ore yet.”

Iron ore futures are down nearly 60% from a record in May.

Wells Fargo Investment Institute senior global market strategist Sameer Samana is also looking at high-yield spreads to get an idea of ​​whether contagion is coming. For him, the sell-off of US stocks has much more to do with extreme positioning and a relentless buy-the-drop mentality that may have reduced the sidelined cash normally used during drawdowns.

“Until the high yield spreads in the US widen further, this should be seen as an opportunity in US equities,” he said.

© 2021 Bloomberg

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