Senior Investment Editor
Summary: Markets finally reacted to the uncertainty coming out of China's real estate market as the S&P 500 closed trading more than 1.5 % down on the day Monday. The reaction comes on the back of China's largest real estate developer, China Evergrande Group, or just Evergrande, effectively entering a restructuring phase when local bonds were suspended Thursday - an event that was more or less ignored last week, as our Head of Equity Strategy, Peter Garnry, reported.
Markets are holding their breath until Thursday where Evergrande has two bond payments due. If the real estate developer defaults on its payment there seems to be a real risk that the global financial markets can be thrown into turbulent times – also more turbulent than the event would justify, according to Garnry. “Equities have moved so high that a selloff has long been overdue. Now the Chinese housing market situation became the excuse for selling out. If Evergrande defaults on its payments Thursday, it is fair to assume that markets can go further down even though the Chinese government has the tools and power to soften the blow. It is a serious situation, but it doesn’t have the global scale to merit a new financial crisis,” he says.
The negative global reaction to the Chinese crisis begs the question why otherwise efficient markets correlates things that doesn’t necessarily hang together. As Garnry points to in the above, what is happening in China – while being serious and potentially impactful – can also serve as an excuse for some investors who have moved themselves into a position where they would want to offload a portion of equities but haven’t had a good reason to do so.
To understand this argument, there’s two relevant factors. One is the long-term upwards trend that global equities have experienced in the last year. The second is the concept “Buying-the-dip,” which can be put into the bucket of technical trading concepts. It refers to the idea that once an equity falls sharply – the dip in a graph – there’s a tendency for it to quickly rebound and rise in value again, especially in times where the market generally is trending upwards.
With the positive mood on the markets the past years, it seems as though many investors have bought into this strategy and helped the self-fulfilling prophecy of markets moving up after falling. This, in turn, has moved equities higher and higher and since dips have ended in financial gains there hasn’t been any good reason for investors to sell equities. This may lead some investors to stay long in equities even though their mandate or analyses suggest otherwise. In such a situation, an event like the Evergrande crisis – even though it shouldn’t translate to a global issue – could be a trigger for investors to offload instead of buying the dip.
The question is, then, how much investors will let the markets fall before the dip becomes deep enough for them to ignore the Chinese real estate sector again.
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