September saw equities have a pullback which has halted what felt like a never-ending rise. Bond yields rose as inflation pressures mounted, creating negative returns for passive defensive assets, which in turn negatively impacted valuations of equities. Additionally, concerns over a debt-default by Evergrande, a Chinese debt ladened property developer has spooked not only Chinese investors but global investors more broadly.
Who is Evergrande? Evergrande is one of China’s largest property developers and they own development land in many of the large cities which they then develop and sell the resulting apartments to make a profit. They also have interests outside of property development including automobiles, health, wealth management products etc.
What has occurred? Evergrande have expanded aggressively and as such have a debt burden of US$300bn and are at risk of not being able to pay interest and return capital to its bond holders i.e. a potential default. With domestic banks unable to extend debt facilities due to the company breaching the so-called “three red lines” metrics imposed by the People’s Bank of China (PBOC) and Ministry of Housing the company will need to divest assets, find additional equity or restructure combining asset sales with additional equity possibly by being acquired by another entity. Many properties under construction are at risk of not completing and the properties being sold are being priced at a heavy discount to the original valuations which is impacting home buyers that have paid a deposit and also impacting current home owners’ equity as property prices have fallen by around 20% in some instances. The contagion effect to Chinese property values and the economy is real.
What’s next? A restructure of Evergrande is most likely with any agreed terms having to meet the approval of the PBOC and Ministry of Housing to ensure refinancing of the company’s domestic debt obligations can occur. Non-core assets will be divested and a partnership with one or more Chinese property developers is likely to ensure customers receive apartments they have paid for. This doesn’t necessarily mean all debt obligations will be honoured with international investors/lenders appearing most at risk. The Chinese government will be keen to “ring fence” Evergrande’s problems and instill confidence in the population given the property sector accounts for over 25% of the country’s GDP.
The Australian share market was negative in September with large caps down 1.9%, International equities fell 3.7% on a currency-hedged basis. With the AUD falling by one cent versus the US Dollar to US$0.7213 unhedged equites fell by 3.0%. US equities were the main driver for the sell-off as US Technology “Growth” stocks sold off in response to bond yields rising and the negative impact on valuations.
Bond yields ended the month higher led by a surging oil price as demand improved, indicating an uptick in economic activity. Bottlenecks in the supply chain for many products have seen inflation expectations rise and therefore being priced into longer bond yields. The fuel shortage in the UK with petrol rationing occurring can be linked to the panic toilet roll buying that we have all witnessed, there is supply but there is a lack of delivery drivers. Additionally, bond markets reacted to an expected reduction in central bank liquidity provisions possibly starting by year’s end. These provisions have been in place post the pandemic to suppress cash rates, bolster liquidity and encourage borrowing.
The Australian 10-year government bond yield increased by 34bps to 1.49% and the 2-year government bond rose 3bps to 0.04%. In the US the 10-year government bond rose by 18bps to close at 1.49% and the 2-year government bond yield rose by 7bps to 0.28%.
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