EVERGRANDE
- John Authers: Investors Needed a Catalyst to Shatter This Market Calm Markets were ready for a fall and China Evergrande has obliged, though U.S. stocks have gone only halfway to a correction.
Fleetingly, the U.S. stock market managed to get halfway to a correction. By 3:30 p.m. New York time Monday, the S&P 500 stood 5.1% below its all-time peak from earlier in September, on an intra-day basis. Then came the now-customary dose of “buy-the-dip” buying into the close. (…) But the afternoon rally demonstrates that the stock market continues to have a friend in TINA — and the assumption continues to be that TINA will still have a friend in the Fed when the Federal Open Market Committee meets. (…)
- Evergrande Declines Further After S&P Says Default Is Likely “We believe Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy,” according to an S&P report dated Sept. 20. “Evergrande failing alone would unlikely result in such a scenario.”
- Goldman Sachs: “Evergrande is large (total assets of RMB2tn, or 2% of China’s GDP) and complex (with over 200 offshore and nearly 2000 onshore wholly and non-wholly owned subsidiaries). But it accounts for only 4% of China’s total property sales and its 123,000 employees and 3.8 million contractors make up a fraction of China’s over 400 million urban labor force. In the event of an orderly default of Evergrande and limited spillovers to both the financial market and broader property sector, the macro impact should be manageable”
- OECD sees limited Evergrande fallout
- The real risk from Evergrande The main worry is growth, not contagion
Yet, as Axios says:
Evergrande, the world’s most indebted developer, is the first big test of the global financial system since the pandemic-induced chaos of March 2020. By any measure, an Evergrande debt default would be one of the largest in world history.
To put Evergrande’s $305 billion debt load in perspective, Argentina’s massive foreign-debt default in 2001 was about $93 billion. Greece’s restructuring in 2012 was about $200 billion. Lehman Brothers had about $600 billion in debts when it filed for bankruptcy.
Those defaults shook entire economies. Evergrande seems to be causing little more than some medium-sized market jitters. (…)
Economist Adam Tooze calls it “controlled demolition.”
A full-scale crisis is still possible. But consensus among China watchers is that Beijing has financial firefighters waiting.
(…) The central government has already sent a team to help Evergrande restructure. But this will not be a simple task. Evergrande is not a simple corporate.
The complexities include a bank located in Shandong, under a subsidiary of Evergrande. China’s authorities will need to look at how this bank is related to other financial institutions to avoid a liquidity crunch in Shandong and among smaller banks.
Then there is a pharmaceutical company, and an expressway company that Evergrande has invested in, which are also located in Shandong.
So the restructuring of Evergrande will be of concern to the local government in Shandong – this is not just a simple private owned company.
From Evergrande’s semi-annual report of 2021, total assets as of June 2021 were around 2.2% of China’s nominal GDP. But there could be indirect factors that we should also take into account. (…)
The more troublesome issue is the bank invested in by Evergrande. Did it also lend to Evergrande? Did it have exposure to other businesses that lent to or did business with Evergrande? Which other banks do business with this bank and what are their exposures? These are the questions to which we do not have answers. (…)
We expect that the government’s restructuring team will help Evergrande at least get some capital, but it may have to sell some stakes to a third party, such as an SOE (state-owned enterprise). It could then continue to operate.
The spin-off of non-core businesses, for example, those that are not residential real estate type businesses, will probably be done first. After that could come sales of stakes that are at the core of Evergrande’s business.
How much of a stake would be sold is a big question. Evergrande’s current bond yields imply a very low value of the company. So the stake could be sizeable. We don’t, however, think it is inevitable that Evergrande will be bought out by an SOE and become an SOE itself.
The only comment we feel we can make with some degree of certainty is that the process of restructuring will likely be drawn out. We don’t anticipate a full and complete answer to the current market anxiety any time soon.
As always, the known but often unanticipated unknowns are the financial interlinkages which always emerge after the first accident (e.g. the Japanese property bubble, the U.S. S&L crisis, the subprime mortgage crisis, Lehman).
Morgan Stanley Sees Growing Risk of 20% Drop in S&P 500
While it’s still a worst-case scenario, the bank said that evidence is starting to point to weaker growth and falling consumer confidence.
In a note on Monday, the strategists laid out two directions for U.S. markets, which they dubbed as “fire and ice.” In the fire outcome, the more optimistic view, the Federal Reserve pulls away stimulus to keep the economy from running too hot.
“The typical ‘fire’ outcome would lead to a modest and healthy 10% correction in the S&P 500,” they wrote.
But it’s the more bearish “ice” scenario that’s gaining traction, the strategists said, laying out a picture in which the economy sharply decelerates and earnings get squeezed. (…) and would likely lead to a larger than normal mid-cycle transition correction in the S&P 500—i.e. 20%+.
THE U.S. CONSUMER
NY Fed’s Survey of Consumer Expectations: The median expected growth in household spending over the year ahead rose to 4.2% in August, from 3.6% in April. This is its highest value since the start of the series in August 2015.
From The Transcript:
- “it is true that we’ve seen a bit of softening in travel, in airlines and lodging most particularly. I think, that’s relatively to be expected considering the Delta variant has a little bit knocked consumer confidence, at least temporarily”. But overall, credit card spend, I would say, is robust.. if we look at spend right now, even with that softening relative to 2019, we’re still up 18%, 19% relative to 2019, notwithstanding that those sort of key areas are down. And remember that ours is a portfolio that has a decent skew towards travel and entertainment.” – JPMorgan Chase (JPM) Co-CEO of Consumer & Community Banking Marianne Lake
- “…the goods and services spend remains, the growth rates remain very stable in Q3 versus Q2 and Q2 exit. On the T&E side, throughout Q3, we’ve actually seen growth. So you cited 75% Q3 to date. I think through the first week or so of September, that number is an 87%-type number, 98% in the U.S. and more modest outside the U.S. And I’d say it’s been relatively stable. We did see in August a tick-down in air spending in particular. Early September looks a little bit more robust. (…) goods and services spend does not seem to be impacted in any way by the Delta variant. There clearly is some impact, I think, in the U.S. on T&E spend, but on the other hand, as the U.S. weakened a little bit in August, as I pointed out, across the globe, we saw spend strengthen. A little hard to know what to make of the early days of September since it shows a strengthening again” – American Express Company (AXP) CFO Jeffrey Campbell
- “The second-half growth in GDP is probably going to be a little bit less than people thought 6 weeks ago, 8 weeks ago, but it’s still really strong. And so I think that continues. And despite the noise that, I think, is getting created by the Delta variant, I think you’re still seeing that move forward.” – Wells Fargo (WFC) CFO Mike Santomassimo
- “We generally employ about 55,000 folks in this community. We’re at about 35,000. Ideally, today, remembering, I don’t want to get back to 55,000, there’s a key point there. But we are probably 5,500 employees short of where I’d like to be. And it’s across every spectrum. It’s not — interestingly, it’s not just frontline labor, although it is the biggest portion of it. But it is across frontline management as well. People have through COVID made some different decisions in life. And so, we’re dealing with it. As is everybody else in our industry and frankly, in the country, we’ve had extensive pushes. It’s kind of interesting. We literally have had weeks we hire 500 to 800 people, but we’ll lose 300 or 400 because we’ve gotten people trying jobs for the first time.” – MGM (MGM) CEO Bill Hornbuckle
Border boost for the US economy of 0.75% of GDP The US has announced that from November fully vaccinated foreign travellers from previously restricted countries will be allowed to fly in. This is great news for hard-pressed sectors of the economy and should re-accelerate the recovery in US employment while boosting GDP by potentially more than 3/4 of a percentage point
(…) Looking at the numbers we can see that foreign arrivals totaled 79.4mn in 2019 and plunged to just 9.8mn in 2020 – far fewer Americans travel overseas. Looking at the run rate through the first half of 2021 we were in line for a full year figure of 15.3mn, so an improvement, but it should turn out to be even higher now and much more so for 2022.
Monthly US international travel flows (12M moving average)
This is hugely important for the US economy given the US Travel Association estimates that foreign travellers spent $154.6bn in 2019. Based on a similar spend per trip, this implies that spending fell to just $19.2bn in 2020, a drop of $135.4bn. In reality, the fall is likely to have been even larger given the lack of options on which to spend money once here, given Covid restrictions.
Assuming we get a full recovery in foreign visitors next year (fewer business travellers will likely be offset by more tourists as people make up for lost time) an extra $140bn or so of spending would directly boost US GDP by around 0.6 percentage points. (…)
The broader impact on the economy will be even greater than that. The money that is spent by tourists is focused on accommodation, eating and drinking out, car hire, recreation and entertainment industries – sectors of the economy that continue to lag the broader recovery.
Employment in the US is still down 5.33mn nationally, equivalent to 3.5% fewer people being in work than before Covid struck. For leisure and hospitality it is down 1.7mn or 10% of pre-Covid employment levels! Accommodation (still down 16.9% on pre-Covid employment levels) and arts, recreation and entertainment (down 15%) remain particularly hard hit.
Today’s decision will provide a major boost to these sectors, which will lead to more jobs, higher incomes, more spending by these workers and importantly for the government, more tax revenue. Consequently with multiplier effects this could potentially bring the boost to the economy from today’s decision to above three-quarters of a percentage point in 2022.
U.S. Home Builder Index Rebounds in September
The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo rose 1.3% m/m (-8.4% y/y) to 76 in September, the first m/m rise since April, after a 6.3% drop to 75 in August. An unchanged level of 75 was expected in the INFORMA Global Markets survey. The seasonally-adjusted index was 15.6% below the record high reached in November 2020.
Two of the three HMI components gained this month. The index of present sales conditions rose 1.2% (-6.8% y/y) to 82 in September after a 5.8% decline to 81 in August. The level was 14.6% below last November’s record high of 96. The index measuring traffic of prospective buyers increased 3.4% (-17.6% y/y) to 61, the first monthly gain in five months, after a 9.2% decrease to 59. The index was 20.8% below the cycle high of 77 in November 2020. The index of expected sales over the next six months held at 81 (-4.7% y/y) for the third consecutive month. (…)
INFLATION WATCH
- Shopping Online Is Getting More Expensive FedEx will raise shipping rates at the fastest pace in nearly a decade, adding to pressure on retailers to pass costs to customers.
FedEx Corp. FDX -1.73% on Monday said shipping rates would go up an average of 5.9% next year across most of its services, the first time in eight years that it or rival United Parcel Service Inc. UPS -0.34% has strayed above annual increases of 4.9%.
UPS is expected to release its rate increase for 2022 in the coming weeks. The two carriers have moved in lockstep with their annual price increases since at least 2010, according to Transportation Insight LLC, a supply-chain management and logistics firm. (…)
The higher-than-normal rate hike also is a sign of inflation reverberating across the global supply chain. (…)
FedEx on Monday also said it would raise the fuel surcharge it applies to all shipments starting Nov. 1. The company said the tight labor market and shift in shipping volume have required more-frequent changes to its network and repositioning of aircraft, vehicles and other equipment, increasing its total fuel usage.
That follows a recent adjustment by UPS to its fuel surcharges that raised the cost for many shippers. (…)
Free shipping could go away or the threshold to avoid shipping fees could rise. Costs online and in store could diverge. Some merchants may elect to sell some large items only in store. (…)
- Unprecedented Inflation? That’s What CEOs See No, prices aren’t spiraling the way they did in the 1970s. But expectations matter and manufacturing CEOs are speaking a different language than investors.
Bloomberg adds to my several posts last week citing CEOs and CFOs on inflation at the Morgan Stanley Laguna conference.
(…) “The inflation is unprecedented,” 3M Co. Chief Financial Officer Monish Patolawala said at the conference, warning that the impact from higher input and freight prices on its 2021 earnings would now be at the higher end of the range the company gave in July. Trane Technologies Plc’s CFO Chris Kuehn echoed the sentiment: “Unprecedented is the word we’d use around the inflation side,” he said. (…)
General Electric Co. CEO Larry Culp isn’t one for hyperbole. He calls it like he sees it and to him, the inflationary pressures are “increasingly getting structural in nature.” David Petratis, CEO of lock maker Allegion Plc, expects inflation to stick around for an extended period of two to three years and is positioning his company to be prepared for that. “It’s not a transitory situation,” he said.
Eaton Corp. was expecting the supply-chain bottlenecks that have fueled some outsize price increases to ease this quarter. “Much to our surprise, and to the surprise, really I think of everybody in the industry, we’ve seen that things actually got materially worse,” CEO Craig Arnold said. “I’m hopeful that by the time we get to the end of this year, things have settled a bit,” he added. “But I’ll acknowledge as well — we got it wrong. I think we all got it wrong.” Eaton now expects to fall slightly short of its revenue guidance for the current quarter because it can’t get the parts it needs to meet demand.
Carrier Global Corp. has already raised prices three times this year in an effort to stay ahead of rising costs but the company expects to have to increase them again, perhaps as soon as early January. “The reality is there’s more to come,” CEO David Gitlin said. Aerospace and defense giant Raytheon Technologies Corp. — Carrier’s former parent company — primarily relies on long-term contracts so it has less flexibility to raise prices in response to “real” inflation in commodity costs and the beginnings of pressures on the labor front, CEO Greg Hayes said. “I wish I could tell you exactly how long this transitory inflation was going to last,” he said (…).
- German PPI Surges to Largest Gain Since Early ’70S Oil Shock The PPI excluding energy is up by 1% per month or more for four months running.
- Global Inflation Spike Seen Posing Near-Term Risks to Economy Global central banks need to set out clear strategies for coping with inflation risks as the world economy experiences faster-than-expected cost increases amid an uneven recovery from the pandemic, the OECD said.
(…) “Near-term inflation risks are on the upside, particularly if pent-up demand by consumers is stronger than anticipated, or if supply shortages take a long time to overcome,” the OECD said in a report. “Accommodative monetary policy should be maintained, but clear guidance is needed about the horizon and extent to which any inflation overshooting will be tolerated.” (…)
In the OECD’s forecasts, it now expects inflation in the Group of 20 bloc at 3.7% in 2021 and 3.9% in 2022. While price pressures will gradually soften in the U.S., the organization’s economists reckon the rate will stay above 3% through next year.
“Inflation is expected to settle at a level above the average rates seen prior to the pandemic,” the OECD said. “This is welcome after many years of below-target inflation outcomes, but it also points to potential risks.” (…)
“Supply pressures should fade gradually, wage growth remains moderate and inflation expectations are still anchored,” the OECD said. Still, “a longer period of higher inflation from persisting supply shortages could shift expectations further.” (…)
“Sizable uncertainty remains,” it said. “Faster progress in vaccine deployment, or a sharper rundown of household savings would enhance demand and lower unemployment but also potentially push up near-term inflationary pressures.”
COVID-19
- BioNTech/Pfizer Covid vaccine triggers ‘robust’ response in younger children Companies say data provide ‘strong foundation’ to seek authorisation to vaccinate 5-11 age group