The indebted major property developer Evergrande, the second largest in China has trigger wide-spread contagion fear across the global financial markets. Its slightly over $300 billion worth liabilities on its book have made it a trigger of systemic risk in China with may also kick start a significant degree of social unrest as a Evergrande subsidiary firm has sold wealth management products to retail investors and its employees that account to more than 70,000 people to fund its business operations. Evergrande is now facing cash flow problems to repay the due payments of such products on top of interest and coupon payments owe to banks and its corporate bond holders.
Its recent liquidity crunch has been magnified by the on-going clamp downs spearheaded by the government of China’s effort to reform the property development industry; the pruning of unproductive activities and capital misallocation that have produced excessive froth in the last decade coupled with the recent slowdown in economic activities caused by the pandemic.
Even though Evergrande has appointed debt restructuring specialists but the “silent” from China regulators have become too alarming for the financial markets without any clear clarity on the debt restructuring process coupled with interest/coupon payments on two Evergrande’s corporate bonds that amount to close to $120 million due on this Thursday. All these firm specific risk adverse events have sparked a global contagion stampede on most risk assets yesterday where global benchmark stock indices from Asia, Europe and US have declined by -2% to -3%. Considering yesterday intraday low of 4,305, the S&P has declined by -5.3% from its current all-time high of 4,545 printed on 2 September.
Cryptocurrencies were not spared from the carnage where Bitcoin and Ethereum quoted against US dollar has tumbled by -9% and -10% respectively. Meanwhile, the traditional safe heaven assets such as gold, US Treasuries and the Japanese yen got bid up.
The immediate concern right now for market watchers will Evergrande’s debt crisis kick start a “Lehman moment” that witnessed a horrendous slide of -50% to -70% in global benchmark stock indices during late 2007 to early 2009 or an event that is isolated to China’s property sector?
Let’s examine the performance of a related risk asset class, the SPDR Bloomberg Barclays High Yield Bond ETF (JNK), an exchange traded fund that invest in US dollar dominated high yield (lower credit ratings versus investment grade) US corporate bonds that has a significant amount of $9.75 billion worth of assets under management that has lured in a record of $560 million inflow on a single day in March this year. Interestingly, the decline seen in JNK yesterday recorded a lesser magnitude decline of -0.3% versus the benchmark US stock indices. Also, its relative chart that plots the performance of JNK over the S&P 500 has indicated a recent outperformance since 10 September and its respective rate of change (ROC) of such outperformance stood at 1.35% yesterday, its highest level since 18 August.
Also, a measure of JNK’s performance over the risk-free iShares 20+ year US Treasury Bond ETF (TLT) has continued to stabilise since 19 July which implies that US high yield corporate bonds credit spread has narrowed rather than expand (see below charts for details).
SPDR Bloomberg Barclays High Yield BondSource: TradingView (click to enlarge chart)
Relative strength of SPDR Bloomberg Barclays High Yield Bond vs S&P 500 & US Treasury BondSource: TradingView (click to enlarge chart)
Hence, based on the aforementioned cross asset analysis, the odds do not justify a “Lehman Moment” yet for global financial markets at this juncture. Nevertheless, the clock is still tick down fast on Evergrande and the whole world is watching closely on any form of guidance from China regulators.