‘It wouldn’t be a big surprise to see the market drawdown to continue’: Strategist

Brian Levitt, Invesco Global Market Strategist, joins Yahoo Finance to discuss the market sell-off, outlook on the Fed taper, and the debt ceiling debate amid China property market fears.

Video transcript

- Want to continue this market conversation now and bring in Brian Levitt, who is market strategist at Invesco. Brian, good to see you. So I'd like your take on why we're seeing this aggressive sell-off today. Is it all about China and this real estate developer perhaps collapsing? Or is this just an excuse for folks to get out of this market right now?

BRIAN LEVITT: No. I think it is about China and Evergrande Group. I mean, look, it has been a very long time since we've seen any type of drawdown in markets. So I don't think investors should panic about this. I think in many ways investors were concerned that this had been going on for so long without any type of drawdown. So, you know, you're looking at something like 4% or 5% right now on the S&P 500 peak to where we are.

But it is being driven by concerns out of China and the fear, of course, that investors-- it's a classic story that somebody's overleveraged, and you start to look within the financial system to see who's exposed, and you have concerns that that could permeate throughout the global economy and the global financial system. And that's what investors are assessing right now.

- And they're trying to assess what the ripple effects might be here, right, Brian? So I mean, I we're still learning more about Evergrande and its reach. But could it be possible that this could impact our banking system, our financials, here in the US?

BRIAN LEVITT: Well, I think before we get there, we need to take a step back and get a sense of what the Chinese policymakers are going to do. We've already seen the People's Bank of China respond with the liquidity injection. We also believe that the social pact between the Chinese government and its people is going to drive an outcome here that's not going to lead to a Lehman Brothers-type moment.

So Evergrande probably is too big to fail. And the impact of a default on these bonds, the impact that could have on the Chinese banking system and the suppliers to Evergrande could be quite large. And so we would expect the Chinese authorities to step in and work through a restructuring in order to bridge through this moment without an even more significant incident occurring.

- Do you think then-- so with the contagion, if there is any, is going to be contained like you're suggesting, Brian, do you think that this is going to impact the Federal Reserve's timing on tapering? We know the Fed kicks off its meeting tomorrow. So this could be part-- and I would imagine will be-- part of their discussion in what's happening in China. So what do you think in terms of the Fed's perspective and how this might impact their decision to start to roll back those bond asset purchases?

BRIAN LEVITT: It certainly could. I mean, I think as of now we should consider that the Fed is likely to begin to start tapering its asset purchases in November. Even though that may sound ominous, let's remember they're still going to be expanding the balance sheet. So I think November is a reasonable starting point. But the good news is this is a Fed that believes that they have flexibility and optionality.

And so they're not required to show their hand right now. And they'll see how this plays out. Clearly, if this situation in China gets worse and does start to permeate throughout the global financial system, then they will not be tapering their asset purchases in November. And we may start to be looking towards the beginning of next year. However, if the Chinese authorities respond as we suspect they will, leading this to look more ultimately like a long-term Capital Management moment rather than a Lehman Brothers moment, then we would expect the Fed to continue to move towards the tapering of their asset purchases by November.

So, you know, it's all dependent on how this ultimately plays out. That's why all the focus is on the Chinese authorities right now. Again, we can't imagine that the Chinese authorities want a Lehman Brothers or a Minsky moment on their hands. And we suspect that they will do similar to what the US policymakers did in 1998, bring the creditors together to come up with a reasonable outcome.

- Now, we know historically, Brian, September is a pretty lousy month for the markets. I think it has the worst track record of all the months, usually down about half a percent. And that usually happens in the back half of the month. So do you think that this selling perhaps-- we've seen it before. It can be contagious. Do you think this is the beginning of something bigger, or just this sort of knee-jerk reaction to what we're seeing play out in China?

BRIAN LEVITT: Yeah. I mean, those September numbers may be a little bit of a coincidence and that you end up with these events happening, a few of them during the Great Depression, obviously, Lehman Brothers and a few others that really drive the average or median returns of the market down. Actually, we've had some good Septembers more recently. But here we are again with another one. Look, market drawdowns, or even larger corrections, tend to happen with uncertainty.

And so right now, we're dealing with a lot of uncertainty out of China. We're dealing with the uncertainty around what the Fed is going to do. We're dealing with uncertainty on the fiscal side. So it wouldn't be a big surprise to see the market drawdown to continue. Ultimately, and I think it's most important, is that this is not the end of this business or market cycle. This is volatility within it. And we're awaiting policy responses that we believe will foster a better environment for risk taking. And so think back to where you were coming out of the 2009 crisis. We dealt with a lot, including European debt crisis, that had many people concerned.

This is another one of those events that we think policymakers will work us through. And critically, financial conditions in the United States have not tightened. They've tightened a bit. Not tightened meaningfully. And so this does not feel like end of cycle. This does not feel like something more ominous. Could you have more volatility as we head out into the remainder of this month as we await a policy response? Absolutely. But I would not view this as the end of the cycle or anything more dangerous.

- And then, of course, you're talking about what's happening in Washington. We've got this debt ceiling and a possible government shutdown looming. What happens if they don't raise the debt ceiling? I mean, we've certainly been down this road before. But what might the implications be for the stock market?

BRIAN LEVITT: Yeah. I mean, we've been down this road before. I would say, rather than what if, I would say that it's going to happen. I know right now there's a little bit of a game of political chicken taking place. When we had to come up with a solution when we had divided government a decade ago, we were able to do so. It should be easier to do it this time, given that there's single-party rule and the Democrats could do it through the reconciliation process.

I understand that Speaker Pelosi is saying right now that the Democrats are not going to do it through the reconciliation process. It's beholden on both parties to raise the debt ceiling. But ultimately, I think cooler heads will prevail on this. I come back to Winston Churchill. I don't know if he actually said it. But it was said that he said Americans always do the right thing but only after exhausting all other options. And I suspect we'll do the right thing again here.

- Speaking of doing the right thing, you reference Lehman Brothers. Some thought that firm was too big to fail, yet the government allowed it to happen. And many say that is what sparked the big sell-off we saw over a decade ago. If China doesn't come to the defense of of Evergrande, could this really be a much bigger global problem?

BRIAN LEVITT: Well, it could. But I think the fact that Lehman Brothers happened and the rest of the world watched it happen, I think there's few policymakers around the world that looked at that and said, we want to host that, or we want that on our shores. And so we learn over the years policy making. Policy making gets better over the years. So ultimately, I think the Chinese authorities, again, based on the social pact that they have with their people in order to expand the economy, produce jobs, will step forward.

Remember, Evergrande is a company that hires 200,000 people. They employ about 3.8 million people per year on specific projects. They've got countless number of suppliers. It just doesn't seem to me that that's going to be their approach, to let the company go down without any type of support for the creditors or for the financial system.