This week's sell-off, brought to you by the letter 'C'

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Tuesday, September 21, 2021

Two words that hint of volatility, connected by a third

An ugly start to September, and the even uglier start to this week’s trading session, can be defined using two alliterative words that often unsettle investors.

Correction and contagion.

The first word relates to stocks that, as bulls are wont to remind us, usually go up. That has mostly been the case this year — until Monday, that is, when Wall Street suffered its worst session in four months. The liquidity crisis sparked by Chinese property developer Evergrande has emboldened some analysts who think the market is long overdue for a correction (typically defined as a downturn of at least 5%-10%).

“While the Evergrande situation is front and center, the reality is, stock market valuations are overstretched and the market has enjoyed too long of a break from volatility and Monday's stock market declines are not surprising,” said David Bahnsen, CIO at wealth management firm The Bahnsen Group, with over $3 billion in assets under management.

It remains to be seen whether a correction is in the offing. Still, the word contagion bubbled up more than once on Monday, as Yahoo Finance’s Brian Sozzi explained. Ironically enough, the two themes are connected by a third that also starts with a ‘c’: namely China.

Evergrande's debt has swooned as its crisis has grown more acute.
Evergrande's debt has swooned as its crisis has grown more acute.

Evergrande may or may not be the trigger event that bears have been waiting for. But it has amplified pervasive market jitters about the direction of the Chinese economy, and Beijing’s policy orientation.

China has spent the better part of the summer throwing its weight around in various sectors of the economy, a stark reminder about its unapologetically authoritarian bent. And in a market with a short memory, Evergrande also reminds us that China is littered with economic landmines that have the potential to ricochet across the global economy.

“The problems have been there for so long that most people watching the Chinese economy have just started ignoring them,” China Beige Book CEO Leland Miller told Yahoo Finance Live on Monday. “The major issue here is: Can the government contain the problems within the property sector?”

Evergrande has over $300 billion in liabilities, but only $15 billion in cash on hand, raising worries that it can’t make good on $84 billion of interest due next week, according to a report in Bloomberg. So is this the new Lehman Brothers, Wall Street’s erstwhile investment titan that became synonymous with systemic risk?

Perhaps, but indications suggest we’re not there yet. Safe havens like gold, U.S. Treasury debt and the U.S. dollar are well-bid, but far from levels that would be associated with nervous investors seeking shelter from squalls buffeting world markets.

“Although the impact from Evergrande’s liquidity crisis is enormous, the good news is the fallout hasn’t started to spillover to other markets,” LPL Financial Chief Market Strategist Ryan Detrick wrote in a note on Monday.

“Short-term funding markets are acting just fine in China thus far; remember, it was the money markets in the U.S. that first started to show cracks in the system in early 2008, well before the wheels fell off,” Detrick added.

So, to summarize: Correction? Perhaps.

Contagion? Unlikely, but not entirely out of the question.

Yet day-by-day, the events unfolding in China are rattling investor confidence, injecting more uncertainty and volatility in a market that doesn’t need any more of either. At a minimum, investing in China “has become more complex,” as analysts at Wasatch Global Investors wrote on Monday.

Arguments that China has abandoned capitalism might be a stretch, the firm wrote. However, “besides evaluating a company’s underlying fundamentals, investors must now weigh the extent to which the firm’s business aligns with the policy objectives of the Chinese government,” it added.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

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