As I write this, the Dow 30 is down 775 points, or 2.24%. Gold is up a tad and the equity market is a sea of red. Anything associated with China is getting whacked.
Those who believe in the random market theory, including those who shill mutual funds, would say you can’t predict the market. But if that were true, why did all the principles at the Federal Reserve sell two weeks ago?
Our own Sean McCloskey did indeed predict this September sell-off. Earlier this month, he wrote:
Major Correction and Rotation Loom Over September’s Trading.
According to the wealth of historical market data we have at our disposal, it may interest you to know that September is traditionally one of the worst-performing months for stocks.
Investors call it the “September swoon.”
Sean got that one right.
He’s has been sharing his market expertise with us for a while now. You may know him from the options trades he puts out on Fridays in Energy and Capital or from some of his great calls in Bull and Bust Report. Keep an eye out for more of Sean’s great calls.
Evergrande Runs out of Cash
The market is down because a huge Chinese real estate firm called Evergrande ran out of money. The company is on the verge of defaulting on $300 billion in debt and the stock is down over 80%.
Many are calling it China’s Lehman Brothers moment. You might remember the illustrious bank that was the catalyst for the Great Recession in 2008.
The problem is that global debt is intertwined like a pile of pick-up sticks. You pull one, and they all move. And Evergrande is a big stick at the bottom of the Ponzi debt pile, with 1,300 real estate projects in 280 Chinese cities. It also has investments in a whole range of other industries, including video, EVs, health care, and a theme park.
The problem is that the growth in Chinese real estate fell 90% year over year during the first two weeks of September. Existing home sales went negative midsummer, as did housing starts.
Goldman Sachs put out a research note saying:
Housing activity may deteriorate further in the absence of the government providing a clear path toward an eventual resolution for Evergrande.
As our credit strategy team points out, Evergrande is large (total assets of RMB2tn, or 2% of China’s GDP) and complex (with over 200 offshore and nearly 2,000 onshore wholly and non-wholly owned subsidiaries). But it accounts for only 4% of China’s total property sales and its 123,000 employees and 3.8 million contractors make up a fraction of China’s over 400 million urban labor force. In the event of an orderly default of Evergrande and limited spillovers to both the financial market and broader property sector, the macro impact should be manageable.
My guess is that Goldman Sachs is putting lipstick on this pig and selling China as fast as it can to anyone gullible enough to buy Goldman’s paper. GS stock, as well as other big international banks like JP Morgan and Morgan Stanley, are all down more than 4% today.
It’s ominous to say the least.
Here is the likely fallout for Evergrande:
- The company is heading for insolvency and won’t exist in 2022.
- Those who own the bonds will lose their investment.
- The mom and pops that put down payments on unfinished properties will be bailed out.
- Some CCP-owned property will get the assets.
- All the projects will be finished.
- President Xi will say he crushed the evildoers and protected the little guy, thus bolstering his own power.
- Evergrande’s owners and C-suite executives will be disappeared.
It’s not too late to sell any Chinese exposure. Don’t buy this dip — raise some cash instead. The S&P has broken its 18-month uptrend. The market is expensive and toppy in the short term. For example, the S&P’s P/E ratio is at 38… an all-time high.
Margin debt is also at all-time highs — meaning margin calls could cascade into panic selling across all stocks and assets.
We are overdue for some consolidation.
Having some money in cash is a good idea. When and if the market hits a panic sell-off, you’ll be there to buy the fear.
All the best,