Given the market volatility this week, we thought we would quickly touch base to let you know what we’re seeing and what we’re thinking. The following are our notes on a few of the more notable events of the week:
While concerns over China’s real estate market and corporate debt load are not new news, this week they were pulled into the spotlight by a Chinese real estate developer named China Evergrande Group. The pressing issue is that Evergrande has debt payments due this week and next that they may not be able to pay. Most pressing is an unpaid $84 million interest payment on its dollar denominated bonds due yesterday (Sept 23rd). It has 30 days until it is in technical default. The company is under stress as its leveraged real estate projects have been slowed by the pandemic while the Chinese government is cracking down on debt-laden companies by limiting their ability to take on additional debt. As reported by the Wall Street Journal, the company had approximately $304 billion in liabilities; of that $88 billion is interest bearing and almost half of that debt is due in the next twelve months. Reporting out of China is always hazy, but it is clear that Evergrande is in trouble. The bigger question is whether a default will have a pronounced negative impact on China’s real estate sector, or worse. We believe that a correction in China’s real estate market (already happening) would be healthy, given the prevalence of investment and speculation in real estate, in the country. We also believe that it is in China’s best interest to not let this issue get out of hand. While the Chinese government doesn’t have infinite resources, it seems they are focused on making sure that this does not develop into a, “Lehman moment” referring to the downfall of Lehman Brothers in 2008 that sparked the Global Financial Crisis. As we look back at other market events, we note that it is rare that an event so fresh in our minds and thus the thing we are primed to defend against is the thing that causes markets to decline. Maybe more important, is to keep an eye on the broader Chinese debt along with a shifting economic, social and political environment that pose challenges to future growth and stability. All this said, this is a quickly evolving situation, and we are watching it closely.
The Federal Open Market Committee finished their meeting mid-week and is signaling that they intend to slow their bond buying and may raise short-term rates next year. This is all a sign of confidence in a growing economy and represents a reversal of emergency measures enacted in response to the Global Financial Crisis. This could mean higher interest rates, which is likely a healthy thing, assuming rates do not rise too quickly.
Ultimately, we believe the debt ceiling will be raised. It is anyone’s guess as to the path the legislative and executive branches take to get from here to there. For that reason, we are not making any changes in light of this issue. We don’t tend to bet on politics, because we don’t think they can be accurately predicted. We are prepared for a bumpy road ahead.
UNDER A SHADOW OF DELTA
These events come at a time when the US and the world are getting used to the idea that the Pandemic that many of us – maybe without thinking - spoke of in the past tense when the vaccine rollouts promised to bring life back to normal, at least in the developed world. This is a bigger discussion, but our belief is that the Delta variant (and other mutations that will likely come after) are going to slow down the meteoric economic growth that was expected. That said, we still expect growth in the economy and growth in earnings. If you are interested, we have found this podcast to be an enlightening source of information as the pandemic has evolved. (https://johnshopkinssph.libsyn.com/)
ACTIVELY TRIMMING WINNERS
This past year, we have seen a massive rebound in asset prices. As that has taken place, we have been trimming our winners and buying the laggards (that we want to own). This is a good portfolio management practice, and likely a way to sell high and buy low. We’ll continue to do this as part of our portfolio management activities.
KEEP AN EYE ON THE BIG PICTURE
Since investing is always an act of balancing your options at any given time, we still believe that maintaining current allocations and favoring equities over bonds is a smart strategy for investors with a time horizon that warrants the interim volatility. Currently, our long-term return expectations for stocks range from 8% to 10%, while our expectations for bonds range from 0.5% to 1.5%. In this environment, we still believe that where appropriate, a healthy exposure to equities makes long-term sense.
As always, please don’t hesitate to reach out to us with any questions or concerns. We welcome any and all of your thoughts.
Peter & Tom