Markets

What Now Wednesday – More Bumps to Absorb Ahead of the Beige Book

August 16, 2023

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Major US indexes experienced a tumble yesterday.

This was primarily influenced by losses in Financial Stocks and growing concerns about China’s economic slowdown. This sentiment spread to Asia-Pacific markets as well, causing most regional indexes to drop early this morning. JPMorgan raised its forecast for high-yield defaults in Asia, particularly if China’s property market falters. And there is also the potential for another downgrade in the credit rating of the US Banking Industry, this time by Fitch.

Despite recent sell-offs, it’s interesting to note that US markets are still considered “overvalued and overextended.” Morningstar’s Chief US Market Strategist suggests that it might be a good time to consider selling certain stocks to secure profits while identifying opportunities in undervalued options (we are miles ahead of him on this one!). This observation comes as financial stocks experienced another rough day, largely due to Fitch’s potential downgrade but, coming on the heels of Moody’s – it’s nothing we don’t already know about.

We reviewed our Member Portfolios yesterday and we found little reason to sell our value-based positions – especially as we feel we are very well-hedged for a downturn. I’m not expecting much more than a 10% correction (S&P 4,000 again) given that pretty much all the current threats are realized by investors at this point. With the imminent collapse of Commercial Real Estate

Tao Wang, managing director at UBS, discussed China’s economic challenges and the factors influencing its trajectory. She explained that while China’s 2023 consensus was for a strong economic recovery driven by consumption rebound and property sector stabilization, the reality fell short. The property sector experienced a setback in the second quarter, leading to a slump in overall economic growth.

Wang highlighted how China’s property downturn resulted from various factors, including regulatory tightening, shifts in real estate demand and supply, and the impact of the pandemic. She emphasized that the property fundamentals have changed, including a likely peak in population and slowing urbanization.

The PBOC dropped rates back to 2.5% yesterday and China’s Government approved $28Bn in stimulus but Bank Loans plunged to a 14-year low last month, while deflation is setting in and exports are contracting. Country Gardens is at risk of default, now dragging down other builders and now Zhongzhi Enterprise Group, a Financial Conglomerate with 1Tn Yuan ($138Bn) under management missed payments on investment products, stoking fears about possible contagion in that sector.

Zhongzhi is, in turn, a 33% shareholder of Zhongrong Trust (a major Wealth Manager – like JPM/GS), which is now missing payments as well as the majority of cash-flow now goes to propping up real estate holdings that would otherwise default and cause the firms to take MASSIVE write-offs.

Even as rival firms sought to pare risks, Zhongzhi and its affiliates, especially Zhongrong, provided financing to troubled developers, snapping up assets from companies including Kaisa Group Holdings Ltd. and Shenzhen Wongtee International Enterprise Co. Zhongrong issued more than 10 trust products for the now defaulted China Evergrande Group between 2014 and 2016. The percentage of real estate trust assets at Zhongrong more than doubled to 18% in 2020 from 6.6% in 2017, according to the newspaper.

Those real estate investments have soured after the expected property turnaround failed to materialize. China’s home sales tumbled the most in a year last month, curbing revenue for developers like Country Garden, whose stock and bonds cratered after it missed coupon payments to bondholders this month. This snowball is just beginning to roll down hill, folks…