It doesn’t take much to “shock” folks these days.
“A big week for global markets is off to a shocking start,” Bloomberg declared, in piece summarizing a hodgepodge of ostensibly foreboding developments, not least of which is the Evergrande drama and Beijing’s unfolding property crackdown.
Note to trivialize the situation, but notwithstanding journalists’ faux incredulity at red screens, markets were still waiting for the S&P to achieve a 5% decline as of Monday. Maybe this is the week. We’ll see.
Certainly, the setup was conducive to a swoon. The door is open to a wider distribution of outcomes and a large down day could trigger deleveraging from the (loaded up) vol control crowd on a delay.
One strategist said Monday that any correction is more likely to be “a deep one” than the mild, shallow variety some market participants have spent the last several months predicting.
To be sure, a meaningful drawdown is long overdue, to the extent you can still claim that deep market corrections are inevitable in a world where central banks are marginal buyers of financial assets, including equities.
Of course, that begs the question at the current juncture. After all, the marginal, price insensitive bid is set to fade (figure on the right, below, from BofA).
If it’s the flow that matters more than the stock when it comes to central bank asset purchases, a deceleration in the quarterly pace of net buying is bearish, especially as it’ll coincide with a waning fiscal impulse in the world’s largest economy. Even if Joe Biden manages to get most of his economic agenda through Congress, the US is facing a rather large fiscal cliff.
In any case, when it comes to Evergrande, SocGen’s Phoenix Kalen on Monday reiterated some of the key points from a longer note by colleagues Wei Yao and Michelle Lam. “Given the strong dependence of the Chinese economy on the real estate sector, our economists believe that the risk of an extended, severe, and property-led economic slowdown is rising,” Kalen said, adding that although Beijing might “modestly” dial back the deleveraging push if sentiment continues to deteriorate, market participants may be mistaken to assume Xi will order a “substantial relaxation of the over-arching commitment to deleveraging.”
SocGen now sees a 30% probability of a hard-landing scenario for China, which Kalen noted could entail “disorderly debt restructuring at Evergrande spilling over into downward pressure on property investment, prices and sales” along with potential “policy misjudgments causing an outright contraction in housing sales and investment.”
Of course, that kind of thing wouldn’t happen in a vacuum. The global economy is inextricably linked to China. As Peter Navarro discovered over four years, “decoupling” is impossible.
“The repercussions from Evergrande’s prospective collapse will likely contribute to China’s ongoing economic deceleration, which in turn anchors global growth and inflation, and casts a pall over commodity prices,” SocGen’s Kalen went on to say.
Speaking of commodities, iron ore prices are below triple-digits for the first time in a year (figure above).
That too is a China story, whether you want to blame waning demand, climate targets, the burgeoning property slump or preemptive efforts to manage air quality ahead of the Winter Olympics.
Prices are down some 60% in the space of four months, and had fallen nine days in a row by Monday, the worst stretch in a half-dozen years.
On the bright side, a hard landing in China would almost surely prompt the Fed and other major central banks to rethink plans to normalize policy. There’s always (always) an excuse to kick the can.