China has been making the (investment) headlines as of late, and not in a good way. From its harsh crackdowns on tech companies to the latest Evergrande crisis, investors in the region have been on a wild, stomach-churning rollercoaster. And we’re yet to experience the joy that comes along with this ride.
And then comes the news that a debt-laden Chinese property firm named Evergrande could default on its loans.
Markets fell and then recovered. The major indices (including our beloved Footsie) seem to be back on track. A mere blip in the road?
What went wrong and why does it matter so?
A large Chinese property developer named Evergrande had promised to deliver apartments to around 1.5 million folks who have already paid for them but they are still waiting for their precious keys. This has led to protests in a bid to put pressure on Evergrande to resume their construction work or else they want their money back.
Evergrande is now the world’s most indebted property developer (not something to be proud of) whose business has been slammed by the Chinese (Communist) government’s curbs on real estate lending.
Evergrande’s shares tumbled to an 11-year low and their share price (year-to-date) has shed 85%. Investors lost around HK$200bn (near to $20bn USD).
Evergrande’s 8.25% US dollar bond (due next year) is currently trading at a mere quarter of its face value. This means that there is a measly 1 in 4 chance that investors will be repaid. Ouch.
But it’s not just Evergrande’s shares (and bonds) that have taken a beating. Investors fear that other developers may go also belly-up so they’ve ditched those, too in a bid to protect their cash (or what’s left of it) from taking a further beating.
S&P Global (debt rating agency) has said that Evergrande is “on the brink of defaulting”.
Their only lifeboat in sight is if Beijing were to bail them out which will only happen if Evergrande’s collapse causes widespread risk to China’s economy. I sense this might be the case. Might they just be ‘too big to fail’?
To put things into context, the sum total of Evergrande’s debt is worth $300bn. Apple’s cash pile (and marketable securities) alone is worth a whopping $200bn — enough to wipe out two-thirds of Evergrande’s debt! Someone get Apple on the line, we need their help.
Property bubble: A frothy scene
China’s property market has suffered a long-lasting problem of oversupply and last year, President Xi Jinping (finally) addressed this issue. Beijing soon passed a string of laws that constrained property lending.
When this balloon deflates, the air that leaks out will be sting, least of all because real estate represents one-third of China’s GDP.
This is a sticky problem because Evergrande is the largest issuer of high-yield bonds in Asia. And, in China alone, real estate makes up 42% of its high-yield bond market, with most of the borrowing coming from domestic lenders.
You’re beginning to see how interwoven (and entangled) everything really is.
But it’s not just locals that grabbed a slice of the real estate pie, it was internationals, too from the likes of HSBC to BlackRock. At a time when the world was starved of yields (thanks to rock-bottom interest rates), many institutional investors turned to Chinese bonds as a form of refuge.
It wasn’t only the yield that enticed them, it was the fact that these bonds weren’t as correlated with global markets, adding a layer of bond (and by extension portfolio) diversification. Oh, the irony.
It’s very likely that the state will keep a very close eye on the growth of China’s property and thus the construction sector. This will mean that the demand for raw materials (think iron ore, copper and aluminium) will come to a grind.
The knock-on effects will be vast.
After all, China is the world’s second-largest economy and this is not to be taken lightly. During the recession of ’08, China’s seismic growth sheltered Australia (an exporter of raw materials) from the Credit Crunch. So do not underestimate this region.
When China sneezes, the world catches a cold. Let’s hope that it doesn’t come to that!
Beware, there are others
It’s not just Evergrande that was having issues.
Other property developers’ bonds have also been downgraded such as Fantasia Group and Guangzhou R & F (I’m not going to even try and pronounce that!).
Now, if these developers have trouble refinancing, this could spark economic trouble across China if orders for new home building come crumbling down like a house of cards. Sky-high debt with little to no money coming in is no easy thing.
If Evergrande defaults on its loans, it could send ripples through the wider Asian corporate debt market. With Evergrande resolving domestic payments, there has been no indication whether it would pay offshore holders (a.k.a the Big Boys).
Evergrande has a 30-day ‘grace period’ to meet their $83.5mn interest payments after failing to pay it on Thursday, 24 September. Keep your eyes (and ears) wide open but don’t hold your breath.
With all this talk of financial trouble, the sorry tale of Lehman Brothers’ collapse comes to mind.
Yes, there are parallels but Evergrande’s international debt load (at $20bn) is relatively small and not big enough to hurt global banks (and investors) in the way that Lehman did. I hope that provides some form of comfort.
There is some good news to be had.
Evergrande has managed to resolve a coupon payment with bondholders in private talks and their share price surged by 23% in response. Then came the jab. The People’s Bank of China gave the country’s financial system an injection for a (much-needed) liquidity boost.
Evergrande’s default could have easily spun into a Global Financial Crisis 2.0 but luckily, the firm will be restructured (in what will mark China’s largest-ever debt restructuring) and the collateral damage will be kept locally. (Breathe a sign of relief).
Oh, there’s more good stuff and it comes from none other than our very own Standard Chartered.
It looks like this bank’s appetite for China’s growth will not be stopped by the likes of Evergrande. They reckon that China still has a whole lot of growth left in her, especially when compared to other parts of the world.
This British bank (with its main comings and goings in Asia) has around $6bn invested in Hong Kong real estate with a further $1.25bn in China and yet they aren’t nearly as concerned as the overall market which (I hope) gives us all a much-needed confidence boost.
To add a further dose of optimism, HSBC’s CEO also added some words of solace citing that he doesn’t expect the crisis to impact its own balance sheet, despite impacts on both bond and stock markets.
The bigger picture and the lessons for investors
We can always learn a thing (or two) from crises. Since failure teaches us a whole lot more than success does, there are lessons to be learnt and ones we sure won’t forget.
Firstly, this crisis has shown us that China truly does its own thing. They march to the beat of their own drum and I’m afraid, investors have learnt this lesson the hard way.
As such, investors in the region should tread with caution.
A simple (and cheap) way of gaining access to Chinese firms (if you still want to!) minus all the hassle is through indices/funds so that you don’t have to a) dilly-dally as you try to sift through hundreds of stocks to choose ones that are right for you and b) worry about the performance of every individual stock because, as we’ve seen all too often, investing in China is no small feat.
No one knows what really goes on behind their closed doors.
A longer-term vision is best
When crisis strikes, you have two options.
You can either run away and jump ship (like many do) or, you can be brave enough and weather the storm. I beg you to choose the latter. You’ll be all the more stronger for it and your portfolio will thank you.
The worst possible time to sell your holdings is post-crisis — when the damage is already done and the (lower) price reflects this. So, hang on and ride out the waves.
It is easier said than done but, to quote Franklin D. Roosevelt: “A smooth sea never made a skilled sailor”.
Stick to your (5, 10, or even 20-year) investment plan and be sure to take full advantage of market troughs. Buying on the cheap and selling on the high is what we all want so don’t be afraid to do just that.
Diversification: Your free lunch
While you can’t avoid these once-in-a-decade disasters, you can certainly take some steps to reduce their impact on your beloved portfolios. They say that when it comes to finance, there is no ‘free lunch’ — apart from diversification.
So if I were you, I’d load up on this tasty (investment) meal. Diversification, simply put, means not having all your eggs in one basket for if your one and only basket were to break, you’d lose all your eggs.
Well, no need to fret — we’ve got that covered.
Whether you want to Walk (take on low risk), Run or Soar (take on more risk), ikigai’s ready-made portfolios will sort out all this diversification stuff so that you don’t need to get your hands dirty. Pretty nifty, right?
They’ll be sure that you’re invested across countries and sectors (as well as asset classes) which not only protects you from losses (when some fall others will rise) but it allows you to sleep at night knowing that you aren’t overly concentrated in one area.
When it comes to China, most investors don’t tend to hold more than 5–6% of their holdings in the region (it’s usually more like 2.5%-4.5%) but for those of you that do, remember that markets always recover. The question is how long that will take.
After this crisis, China’s growth may be slightly anaemic but if that’s the case, then other parts of the world will (hopefully) fill that not-so-gaping hole in your portfolio.
My bet is on the UK. Not that I’m biased, of course.
Don’t time markets, ever.
No one knows when markets have reached their lowest point. So don’t try to be smarter (or quicker) than them.
Markets are also over-reactive creatures. We tend to think that they’re wholly rational beings but to tell you the truth, they aren’t. In fact, they possess some very human traits — notably occasional irrationality.
How many times have we over-reacted when the rational response would be to stay calm and do nothing? We may have more in common with markets than we realise!
So, when Evergrande-style crises hit and stock markets fall remember that all they’re doing is getting a little angrier and a great deal more frustrated than they probably should.
And, when markets do over-react, the bargain-hunters (and sheer brave ones) among us will spot this as a great time to enter. But since we can’t time markets when you do jump in there could be some turbulence yet to come. But in the end, markets will always go up and by adopting a long-term approach you’ll be just fine.
On that note, as us Brits would say: Keep Calm and Carry On!
Authors: Dinah Wolf and ikigai
Dinah Wolf is a Finance student with a passion for investing. She has a keen interest in the fintech/start-up space and is on a mission to get more people invested to close the wealth gap. She also writes a popular financial newsletter dinahwolf.substack.com to make finance and investment news fun again!
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