Market Observation – September 20, 2021

Today’s “risk off” day – lower yields and lower equity prices – was prompted by reports that China’s second largest developer, Evergrande, will be unable to meet its upcoming interest payments. According to a BBC article today, a spokesman for the Chinese government indicated that Evergrande needs to save itself and not rely on government support. Evergrande has over $300 billion in outstanding debt to over 171 domestic banks and about 121 other financial institutions.

Most financial analysts who have expressed their opinions today do not expect much of a contagion beyond China’s borders. Within China and in spite of statements by an official Chinese spokesman, we expect that China will somehow find a way to contain any internal spillover effects from the Evergrande situation. It is worth noting, that what makes this especially difficult for the Chinese authorities is that a principal policy of 2021 was to rein in corporate credit, and especially the credit related to the property sector.

As outlined in our most recent weekly research reports, the weakness of equity markets in September, and especially today, should not come as a surprise. We have been advocating buying desired positions only on downturns, given the relative lofty valuations of the S&P 500 and Nasdaq. However, we still expect stronger economic growth in the intermediate term. So even on days like today, we believe there are tactical buying opportunities in Cyclical and Value type stocks. We would also continue to hold big cap, high-quality growth stocks for longer term price appreciation, recognizing that growth stocks might underperform in the short-term, as most of the benefit from low interest rates is already priced into such stocks.

The equity downturn in September, and especially today, reflect the “fear” that if equity averages were down by more than roughly 2%, the downturn would accelerate. That is what is transpiring today. We still expect that equities remain attractive in the intermediate to long term and these bouts of volatility will continue.

To reiterate, while we might see more instability in the short term, we expect that China will eventually contain the economic impact from the Evergrande debacle and that the Delta variant’s negative effect on economic growth will be overcome. We therefore continue to favor a modestly overweight equity position.

 

Previous Commentary

August 27, 2021 summary: “The overall market is discounting mostly favorable economic and inflation expectations. Market volatility could begin at any time.”

September 10, 2021 summary: “We believe that the overall U.S. equity averages are at an increased risk of a downturn in the short to intermediate term. High valuation, excess liquidity, artificially low interest rates and low volatility in the overall averages along with extremely one-sided bullish positioning make these averages very vulnerable.”