While the main blog is going to be focused on education, I would like to start new series with the weekly news having the largest impact of the world markets. I will start with the markets overview and then follow up with a couple of focus topics. The aim is to have these updates on the weekly basis, released over the weekend. The blog version of the weekly updates will include additional links that you can follow for more information. Today we will cover:
US Markets overview
The equities investors have celebrated a very fortunate week with a massive move in stock prices. The largest increase in S&P refreshing its six-weeks highs occurred this Wednesday with the FED hiking rates by 75 basis points. The price increase continued during both Thursday and Friday trade sessions. The notable week’s earnings of Amazon and Alphabet (owns google) on Wednesday, and Apple on Thursday have also contributed to the stock markets growth.
The Fed’s hike comes as another attempt in limiting the inflation, which was called transitory until recently. Let’s hope the recession that has been signified by the second quarter of economy contraction is not going to follow the lead of being transitory in the same manner. Supply and demand post-Covid challenges together with Russian-Ukrainian war are named as the main motives for the hike. On the annual basis, the Gross Domestic Product’s (GDP) contraction was 0.9% in the second quarter of 2022 (vs. 0.5% growth expectations), and the annual inflation was reported to be at a whopping 7.8% level in the latest quarter. As a reminder, the Fed’s inflation target is 2.0%, which seems to be unattainable this year.
EU Markets overview
The EU markets have also experienced a positive week with STOXX Europe 600 ending the week 2.9% higher, Germany (DAX) 1.7% higher, France (CAC40) 3.7% and Italy (FTSE MIB) returning 5.63%. The key underlying reason for these gains is lower concerns about the Russian gas. The pipes servicing over the last weeks has not resulted in Russia shutting down the supply to the European countries, which was the primary concern over the last month.
There were no changes in the monetary policy this week and the lower market risks have resulted in falling bond yields across the main EU markets.
The markets strengthening, however, may be short lived as the July inflation of 8.9% has trumped the June level of 8.6% as reported by Bloomberg. We are going to learn more next week, however there is no specific indication that European Central Bank (ECB) aims at another hike soon. The reluctance to make another hike could be a result of poor economic sentiment metrics.
Focus theme: China real estate crisis
There is an ongoing real estate crisis in China that threatens the financial sector in a very similar manner to what has happened in the US in 2008. The entire real estate sector is overleveraged and has a huge debt problem similar to 2008 situation. In US the CDFs and sub-prime loans have played a strong role in the crisis. The key difference is that the US banks could realise the finished mortgaged properties in the market at loss, in most cases the properties affected by the crisis in China simply do not exist or are at the early construction stage.
The key development company linked to the crisis is Evergrande Group. It has sold majority of its developments at the plan stage and the proceeds were frequently used to purchase additional land for development rather than directly allocating it to the construction. The market risks from Covid and rising inflation have led to insolvency of this firm with failure to pay interest on its 20+ billion of outstanding USD denominated debt in December 2021.
While preparing this material, I have visited their website and had a chance to learn the meaning of Evergrande’s name. “Ever” stands for ‘never-ceasing existence through the ages’, which is quite questionable now, and “Grande” stands for ‘universal growth’, which is off as it fails to indicate the extreme level of leverage and reckless business expansion approach.
The Evergrande case has a knockdown effect on the Chinese and can impact the global economy. Failure of the large developer hurts the current investors and modifies the risk consideration of future investors. Those who have purchased the properties at the plan stage had to pay their mortgages despite the properties being either unfinished or not even built. In some cases the projects at the early stages were frozen and demolished. The owners of such non-existent properties are currently boycotting their mortgage repayments, which poses additional risks to the banks and pressures the government to intervene. The initial response was that the government sees any intervention as something that could incentivise other developers to undertake riskier business practices, however the scale of the problem is so large that the number of protestors on the street is creating the political risks on top of the systemic banking risks.
This week’s news about Beijing’s plan to set up a real estate fund worth CNY 200 billion to CNY 300 (approx. USD 45 billion) billion aimed at supporting distressed developers comes as a relief. Despite that, this money is unlikely to address the entire problem as the total liabilities of Evergrande stand at roughly USD 300 billion with around 20 billion off-shore debt that has already defaulted.
It is estimated that the Chinese real estate assets will experience double digit losses this year. The knockdown effects of this crisis will likely exacerbate the poor state of the world economy struggling from supply chain failures and geopolitical conflicts.
Please note, none of the information on this blog represents the opinion of my employer and all information does not represent a financial advice.
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