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Analysis-Investors grappling with Evergrande fallout weigh risk of wider pain By Reuters


© Reuters. FILE PHOTO: An exterior view of China Evergrande Centre in Hong Kong, China March 26, 2018. REUTERS/Bobby Yip/File Photo

By David Randall, Maiya Keidan and Svea Herbst-Bayliss

NEW YORK (Reuters) – Investors unnerved by the fallout from heavily indebted Chinese real estate company Evergrande were gauging the potential for a wider shakeout after a selloff hit stocks around the world.

For now, many U.S.-based investors believe there is little chance that the woes of Evergande, China’s second-largest property developer, could morph into a systemic crisis reminiscent of the 2008 collapse of Lehman Brothers.

Still, with valuations on U.S. equities stretched on a historical basis and an unwind of the Federal Reserve’s easy money policies looming, some worry that a sudden drop in risk appetite could leave global markets vulnerable to a broader selloff.

Rob Romero (portfolio manager, Connective Capital), a tech hedge fund that manages $100 million, said, “We have an extremely cautious view of the market given high valuation levels.” It is difficult to predict how widespread the contagion could spread. We are looking for signs of resilience in U.S. market; if that doesn’t happen, that means contagion has more risk to snowball.”

Investors and analysts are expressing concern about Evergrande’s impact on the global financial market at a time of high valuations.

The benchmark traded at 21.6 times forward earnings as of Friday, near its highest levels since the late 1990s dotcom bubble, and prior to Monday’s trading had rallied more than 18% for the year to date.


While Evergrande’s woes have been playing out for several months, its shares tumbled more than 10% on Monday as Chinese regulators warned that its $305 billion in liabilities could lead to widespread losses in China’s financial system if its debts are not stabilized.

The company’s late payments could lead to cross-defaults.

The MSCI Global fell 1.62% on the back of fears about a wider default. This is its lowest performance in the past two months. Treasuries were a popular haven for investors, with the yield on the U.S. 10 year falling to one-week levels. However, Treasuries’ 10-year U.S. rate swaps against Treasuries was at its widest level in six months.

Analysts also pointed out the rise in Libor over the past three months to 12.5 base points (a peak of four weeks), as a sign that there is concern in money market markets. This is a result of concerns about possible stress within the global banking system. [L1N2QM1UV]

Robert Sears from Capital Generation Partners said that while institutional investors appeared not to have taken an Evergrande overleveraged position, it was unlikely that this would lead to liquidity crises.

“So far most of the negative action () been in the Chinese property sector,” he said. “I don’t think this has had a major impact on most hedge funds so far.”

In the U.S. equity options market, traders appeared more intent on taking profits from existing hedges than on buying up protection against a sharper selloff, even as the stood around its highest level in four months [.L1N2QM1L2]

Andrew Left, founder of Citron Research, which in June 2012 published a report that said Evergrande was insolvent and had defrauded investors, was also not expecting widespread pain.

He said that he didn’t believe that the crisis will be the end of the global economy.

Indeed, some investors said that Monday’s price declines should have been expected given the rally in the S&P 500 over the summer and concerns ranging from the debt ceiling debate in Washington to the prospect of higher capital gains taxes.

“Coming into September we thought that with valuations and optimism so high that investor sentiment seemed a little vulnerable to a dramatic but short-lived shift,” said Brian Jacobsen, senior investment strategist at Wells Fargo (NYSE:) Asset Management.