The project looks like the set of a horror film. Half-finished apartments blocks stand empty and abandoned. Following the credit crisis of 2008, China was booming. And everyone wanted a part of it. Fast forward 10 years, and we're now witnessing what happens when you drive really fast down a windy road.
With a model of rapid, debt-fueled expansion, China Evergrande Group was, until recently, the world's largest property developer. I won't go into the details of the story, you can read it here.
Here's the company's share price since it listed in 2009:
What did you think was going to happen after the share price climbed 550% in a matter of months?
Talks of contagion are making headlines, parallels are already being drawn to the collapse of Lehman Brothers in 2008, and what Evergrande's collapse could mean for the Australian property market.
But so far, these concerns are not showing up in parts of the credit markets that have served well as red flags for broader credit crunches in the past, according to Bespoke Investment Group (BIG). The chart below (credit: Bloomberg, BIG) shows credit default swap spreads for the big money center banks and brokerage firms in the US. A credit default swap pays out its holders when a company defaults, so the pricing of these credit instruments is a proxy for default risk. Higher spreads indicate greater risk of default, generally speaking. So far, these areas of the credit market aren't showing much concern over the impacts of a potential default for Evergrande.
To put things in perspective, the chart below shows the largest global corporate bond default each year since 1994 (thanks to Deutsche Bank).
China Evergrande Group has just under US$20 Billion of offshore bonds, which would make it the largest default of 2021. Having said this, it appears as though it's not out of line with the scale of post GFC defaults each year.
Here are my thoughts:
99.95% of investors have probably never heard of this company until last week, and within a matter of days, everyone is an expert on the matter - give me a break.
There are no shortages of after the fact explanations, I just wish they had the foresight to warn us beforehand.
No one knows how the Chinese government are going to handle this. And no one knows how this thing will play out.
Doing anything now, after the fact, is just reacting. The news is out, and prices have already reflected the news.
Media outlets always have something to talk about. There will always be a reason why the market should collapse. The difficulty is in the filtering of the noise to determine what is relevant to one's long-term plan.
Bad news sells. Good news doesn't.
I have no idea how this is going to play out, but I am confident I know what it means for our clients. This may sound contradictory to you, yet I have never been clearer in my mind.
There is a difference between facts and opinions. Understand how to distinguish them. If you are dishing them out, be clear on where you stand.
Trying to identify patterns in independent, random variables is a human bias. I get it. It's just not a very useful predictor of the future.
Diversification and prudent planning never gets old. It's the only free lunch in town - yet most investors walk right past it.
If your entire financial plan is at the mercy of one stock, you either don't understand your plan, or you don't have one.