Last Friday, I talked about how Chinese property developer Evergrande’s impending bankruptcy was the biggest potential risk to the bull market.
At the time, there was no evidence of contagion into international markets.
That all changed on Monday…
On Monday, the Nasdaq-100 closed down 2.18% and Evergrande became international front page news.
Evergrande is one of China’s biggest property developers. It has assets equivalent to 2% of the country’s GDP and could default on its debt as soon as Thursday.
It has about $300 billion in outstanding U.S. dollar debt. No one knows for sure how big its off-balance sheet liabilities are. That’s where the risk is centered.
In fact, China’s property bubble is one of the largest in history. The potential trouble a crash would cause is so large, most investors believe the government would have to bail the sector out.
Right now, it looks like the Chinese government will allow Evergrande to go bust. Shareholders and bondholders will be burnt. However, they are also likely to do everything possible to rescue the remainder of the property sector.
That suggests we can expect more positive headlines in the near future. China would likely have to inject the equivalent of hundreds of billions of dollars into the economy to avoid a debt shock. That should be good news for asset prices.
If that’s the case, maybe we should be thinking about buying the dip…
China’s Saving Grace
But while the Chinese property market is close to falling, the tech sector is rising…
It’s a similar situation to the tech sector in the U.S. following the credit crisis in 2008. Everything that was associated with mortgages, banks, and finances crashed. The tech sector bottomed early. A decade later, it was the biggest sector in the world.
We are looking at a potentially similar situation in China today. The tech sector has sold off aggressively over the last year because it has been the focus of the government’s attempts to exert control over the economy.
Many of the big Chinese tech companies are trading at substantial discounts to their U.S. peers. More importantly, they are beginning to exhibit relative strength compared to the wider market.
While the major Hong Kong indices were breaking down to new lows on Monday, the majority of tech companies held steady.
It’s looking increasingly likely that the government’s focus is now turning to the property sector, giving tech stocks the chance to finally recover.
And it’s likely that many institutional investors will look to accumulate positions in Chinese tech companies during this crisis. Since stocks are holding up, this suggests they are already having an influence.
A great way to gain broad exposure in the recovering tech sector is through the Invesco China Technology exchange-traded fund (ETF) (CQQQ). CQQQ has not broken to a new low and was quite stable over the last week despite news of Evergrande’s problems gaining traction.
All the best,
Contributing Editor, Market Minute