While the U.S. is not immune to disruptions in other parts of the world, we do not view the situation in China as a contagion risk that will derail the bull market.

The financial media are filled with stories about the dire condition of China Evergrande Group, one of China’s largest property developers. Evergrande is the second-largest property developer in China and the world’s most indebted. However, its debt burden is not news to bond investors who have increasingly required very high yields to lend to the company. In fact, three major credit-rating agencies have downgraded its debt deeply into junk territory, reflecting their view that the potential for a default is imminent.


Although a technical default may occur—reports are circulating that Evergrande will fail to make its scheduled interest and principal payments due this week—the ultimate ripple effects seem contained but aren’t completely known. Absent government intervention, a default would be messy. Most of the company’s assets are unfinished properties that will require additional capital and build-outs before they can be sold. Furthermore, its portfolios of completed properties may not be easy to sell in a residential market that was already experiencing a slowdown. Indeed, these concerns could weigh on the overall property market by sparking other anxious developers to slash prices to move their own inventories.

There is also a risk that the government wants to make an example out of Evergrande, to impose some discipline on property buyers and developers. Despite repeated warnings, Evergrande has not fully complied to policymakers’ recently established guidelines to rein in property market excesses. This may not suggest Evergrande will be left to fail, taking bond and common stock holders down along with it, but Party members enforcing President Xi’s mantra of “common prosperity” might turn away from offshore investors and wealthy members of the company’s management.

As China goes, so go other economies reliant on its appetite for imports. Therefore, the hit from an Evergrande failure, predicated upon how it is triaged, could not only impact China’s growth but have spillover consequences to other markets as well. Resource economies like Brazil, Chile, and Australia that export iron ore, copper, and other base metals to feed China’s construction and infrastructure, could be hurt. Even Europe- and Japan-based suppliers of machinery, equipment, and raw materials could feel a chill.

While the U.S. is not immune to such disruptions in the rest of the world, it is generally less susceptible to isolated troubles, especially when financial institutions in America have minimal links to the Middle Kingdom.


The bottom line is that we do not view Evergrande as a contagion risk that derails the bull market. Certainly, policymakers may want to make an example of it, but not to the point that they will stand by in the face of a broad contagion. In a worst-case scenario, a credit event could ripple across China and into some neighboring markets, tempering investors’ enthusiasm for risk for a short while. However, we believe it is unlikely to impart a severe or lasting impulse in the U.S.


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Mark Luschini

Chief Investment Strategist, President and Chief Investment Officer, Janney Capital Management

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