China’s property woes are coming to a head – so what happens now?

Before we get started this morning, I just wanted to let you know that early bird tickets for this year’s MoneyWeek conference are now available! Grab yours now! Given what’s going on in markets this very day, I think you’ll want to make sure you attend: here’s where to book.

So now onto the main topic – you might have noticed that markets were feeling a bit jittery last week. Turns out that they’re finally waking up to what’s going on with troubled Chinese property developer Evergrande.

The collapse has been a long time in the making, but now we are very much in “push comes to shove” territory.

Whatever the Chinese government has planned, we’re likely to find out this week.

Why the Evergrande situation is likely to come to a head this week

Evergrande has been described as China’s Lehman Brothers. It’s a big, heavily-indebted company whose debt has trickled into lots of parts of the economy in a fairly opaque manner. That debt is tied to property markets and house prices, which have been sliding in recent months as China has cracked down on speculation.

So the fear is that if China just let Evergrande go bust then we’d have something similar to what happened after 2008 in the US.

The obvious retort to this has been that 2008 set the strategy book for every other possible crash – for governments and central banks to step in and bail everyone out. That eventually happened after 2008. It eventually happened after the eurozone crisis. It happened during the pandemic (see below). And the assumption has been that it would happen for Evergrande.

However, while Beijing has been doing some stuff behind the scenes (injecting money into the system on Friday for example, and lining up some restructuring specialists for Evergrande), a grand bailout plan hasn’t been unveiled yet. And markets are now getting nervy.

One problem with these things is that it’s much better to step in before a run gets going. The Federal Reserve’s actions in 2020, at the height of the pandemic panic in markets, show that the US central bank has taken that lesson to heart. At the first sniff of credit markets shutting down, the Fed just went all-out to underwrite the entire market, and not just in the US.

Yet the problems with Evergrande are starting to creep into the rest of the Chinese property sector, because people are waking up and realising that this is not just about Evergrande – lots of companies build or sell houses, and houses just aren’t selling right now.

So why does it seem likely that a solution will come this week? Well, as Eoin Treacy of FullerTreacyMoney.com points out, the Chinese holidays (the market is shut on Monday and Tuesday) make this a pretty good week for the authorities to step in – while markets are shut – to make their move.

But more importantly, Evergrande has interest payments to make on two notes on Thursday. They’re not expected to be paid, but some sign of the Chinese government erecting a firebreak to prevent “widespread contagion” might be forthcoming.

John Authers puts it well when he says in his latest Bloomberg newsletter that Evergrande is more likely to be an LTCM moment rather than a Lehman one. He’s referring to the US bailing out giant hedge fund Long-Term Capital Management in the late 1990s, rather than letting it collapse.

Don’t go selling everything

I still think this is probably the most likely outcome. That said, people might well be overestimating the power of the Chinese government. It’s worth remembering that one key reason we favour capitalism and free markets over communism and central planning  is because the former is more efficient than the latter.

This is not even politics, it’s just logic. If one person tries to guess what 1,000 people are likely to need for the coming five years and plans supply and demand accordingly, you’re going to get a worse outcome than if those 1,001 people can just interact freely to adjust supply and demand in real-time. 

This centralised nature means that Beijing has an awful lot of competing and conflicting priorities, and there’s a lot of complexity to deal with here. Lots of stuff could go wrong. So that’s why I’m loath simply to rule out something more akin to a Lehman Brothers moment, even if it’s not my central scenario.

But what does it mean for you as an investor?

As I said last time, I still don’t think there’s any point in you making big changes to your portfolio over this. To be clear, when I say this, I’m making some big assumptions. I’m assuming that a) you have a clear view of your own asset allocation; b) that you have a clear long-term investment plan (ie how much do you need, what for, and by when?); and c) that you are up to date with these things.

If you’re not nodding along to all or any of those points, then you should take some time to resolve them. You certainly shouldn’t be trying to second-guess the Chinese government when your own investment housekeeping isn’t in order.

That’s not me guilt-tripping you about your admin, it’s just that if you don’t know what your plan is, then you’ll make short-term mistakes and you’ll almost certainly lose money by doing so.

With all that said, there are probably two main ways this can go. One is that China – through overconfidence or recklessness or a surfeit of communist joie de vivre – simply steps back and lets the cards fall where they may. Put bluntly, that would terrify everyone.

That said, if you’re living and investing largely outside of China and its sphere of influence (which you most likely are) then you have to remember that even if China’s authorities don’t step in, then our own are likely to do so if it looks as though there’s a serious risk of contagion outside China.

Moreover, if China does step in with a convincing bailout package, then there’s every chance that investors decide it’s “off to the races” time again, just as they did when the eurozone crisis finally had a line drawn under it.

In the longer run, a slowdown in the Chinese economy is something that global markets will have to contend with, but we can discuss that at a later date.

For now my point is this: Evergrande might be scary and you will see some scary headlines. But if you have a plan you’re happy with, there’s no reason to change it. And you certainly shouldn’t flog everything and jump to 100% cash because if you don’t have a crystal ball – that’s pretty much never a good idea.

If you haven’t already, book your ticket for the MoneyWeek Wealth Summit in November – it’s virtual, but I’ll be there with Merryn, so we’re likely to have a better idea of the outcome by then – so you can ping me all your difficult questions on it, on the day.