Market Update – 9/24/2021
The global stock market plummeted on Monday due to fears that China Evergrande Real Estate may be unable to repay its debts. While it may not have a major direct impact on the global financial market, it has been continuously cited as the reason for the market decline.
Though Evergrande’s situation has not improved, the US stock market rose sharply after the Federal Reserve announced its expectation for future interest rate increases on Wednesday.
Evergrande is one of China’s leading real estate developers. Under the Chinese government’s policy of curbing housing prices and restricting real estate industry, the company may be unable to obtain new financing and pay creditors on schedule due to its long-term reliance on financing leverage (liabilities of more than $300 billion, close to 2% of China’s annual GDP). This directly affects pre-sale housing investors, construction contractors, 200,000 employees, lenders, and overseas investors.
Real estate has long been a major focus of China’s economic development and investment. 80% of wealth from urban residents is held in real estate in China, compared to only 33% of wealth in America. This obsession with real estate is due to cultural upbringing, the perception of real estate as a safe investment, and limited options for other financial products.
Driven by endless market demand, developers continue to build houses and borrow money to repay old debts. Real estate has become the locomotive of economic development and the investment target of idle funds.
As early as 2016 and 2017, the Chinese government emphasized that “houses are used for living, not for speculation” and enacted various policies to control the market with limited results. The new “Three Red Lines” policy that took effect this year appears to finally have an effect by forcing financing restrictions on developers.
Whether Evergrande goes through bankruptcy or reorganization, it will have a huge impact on China. Aside from creditors and investors directly related to Evergrande, there are still many other developers with similar situations. Real estate accounts for approximately 25% of China’s GDP, and whether it will cause a domino effect is unknown. In addition to China’s already slowing economic growth, a series of controls on technology and real estate may cause a further negative impact on economic development.
The direct impact on the world is limited and the probability of another Lehman Brothers situation is low. Although there are many well-known foreign investors such as Blackrock, UBS and HSBC involved, overseas debt is estimated to be only US$20 billion.
However, the indirect impact on the global economy should not be underestimated, and the subsequent handling of the Chinese government may also have a long-term impact. Although China currently has less influence than the United States, it is still the world’s second-largest economy and will have a major impact on the global economy once its growth slows. On the other hand, the Chinese government seems to have instructed local governments to prepare for the aftermath of Evergrande’s bankruptcy, signaling that it will not directly intervene.
“Put all your eggs in one basket, and then watch that basket” is also a good investment strategy, but the focus should be on the latter half. Real estate is a necessary part of asset allocation; however, blind belief in “real estate will never fall” or “Evergrande is too big to fail” will result in excessive concentration on investments with a “low risk” perception, and may be more prone to permanent damage than a diversified portfolio.
