Giles Coghlan, Chief Analyst at HYCM, joins Yahoo Finance Live to discuss the outlook on China’s Evergrande default risk.
- The biggest sell off for this market since October of 2020, also a volatile day, the VIX index up about 30%. So its biggest jump since May. All of this is because there is fear that a real estate developer in China, one of its largest, Evergrande, could default on its loans. And the fear is there would be a ripple effect around the globe, somewhat similar to what we saw here with Lehman Brothers back in 2008 and 2009.
For some analysis on this, I want to bring in Giles Coghlan, he is chief analyst at HYCM. And Giles, thanks so much for being with us. We spoke with a global market strategist earlier from Invesco, who said Evergrande was too big to fail. And he thought, the Chinese government wouldn't allow that to happen. Would you agree?
GILES COGHLAN: Yes, I think that would be a fairly accurate assessment of Evergrande. The only caveat to the idea that Evergrande is too big to fail is that if President Zi's moves against Tencent, Alibaba, Didi, as well as these moves against Evergrande, is this president Zi trying to roll back a decade long move towards Western style capitalism? And I think that's the outlying risk that investors will be concerned about.
I think this crisis will move along. I think it will fade into the background. I think markets will recover pretty quickly, maybe as quickly as tomorrow. But the wider issue is, is this a bigger move from President Zi? Is he moving away from Western style capitalism much back more closely towards socialism?
And I think that, on a medium term perspective, may be more worrying for investors considering that China is the world's second largest economy. So I think there are a medium term risks. But in the short term, I think Evergrande will be bailed out in some form, or at least, allowed to fail in a structured way.
- So you bring up a good point, though, because if the markets are going to be just have this sort of-- we've been calling it a knee jerk reaction to the news in China. But longer term, we've seen how China has been cracking down on big tech. Now, it seems as though financials, banks, real estate could be next. If that were to happen, what would the longer term issues be. And could it be a systemic issue within China's financial system?
GILES COGHLAN: Yes, I think it could have some pretty significant impact. For quite a while now, China's been wrestling with a few problems. One is there's been a big fall in the birth rate. There's an overreliance on speculation in the real estate sector. It's either sort of somewhere between 17% and 24% of China's entire GDP is located within that sector. There's a widening gap between the rich and the poor. And also where does the Communist Party fit as private companies are becoming more and more powerful?
So there's a sense of an ideological question that's flowing through into the financial markets. And that will have to work its way through. Now, exactly, how that manifest is very difficult to project at this stage. But I think investors will be looking and marking this as a potential shift that started to grow in pace. And President Zi's actions will be very carefully monitored here, particularly, his policy announcements heading into Christmas and the turn of the year.
- I don't know if you can answer this, and it is just one company, but it's a large one. If Evergrande is allowed to fail to some extent, what would exposure be to some US companies, especially within our banking system?
GILES COGHLAN: Yeah, I'm not sure exactly what the exposure is of the US banking system to Evergrande at risk. A couple of observations that I can make though. First of all, it's not a huge surprise. Evergrande share price has been falling slowly over the last six months. So it's lost nearly 85% of its value during that time. And people have been talking about this for a certain amount of time. So I don't think it's a black swan event. It certainly hasn't taken the market by surprise.
And I think that most investors will be pretty well prepared for this. And I don't think Evergrande will be allowed to fail, because even if President Zi does want to move towards a more socialist style, it's not a great advertisement for a new policy change, allowing a market collapse. So I think he would structure the collapse.
- Do you see that in the foreseeable future, the US cracking down on some Chinese listed stocks here in the US and perhaps moving to delist them as China cracks down on more and more of its big industries?
GILES COGHLAN: Yeah. Well, there's the twin risk. There's the risk of moral hazard, which is what Evergrande is underlining, isn't it. But if Evergrande thought it was too big to fail, then President Zi has an opportunity to say no, no one and nothing is too big to fail. We're not going to allow pursuits of our GDP at any cost.
The other gutter is the fact that China won't be saying, that we're going to allow companies to do exactly as they want. And so we could potentially interfere with tech companies. We can interfere with education companies. And that will be a deep concern to US investors, because you won't be feeling that you're investing into a market, where private capital is king. Instead, the king, as it were, would be the agenda of the Chinese government.
And that may or may not align with the desire of US investors. So I think that would result in further regulations, further delisting, and concerns about US investors as their interest are no longer aligned.
- So you said earlier that you think, perhaps, this big sell off we're seeing on Wall Street might just be a one day occurrence. Do you think we might see the same in Hong Kong? I mean, their market fell to the lowest level in about a year. But they didn't have the supports of the rest of the Asia-Pacific because so many of those markets were closed for a holiday. So do you think that market might be able to bounce back just as quickly?
GILES COGHLAN: Yeah, I think there's a death-- I think there's a sense in which we'll get some kind of response from China pretty quickly. Now, they are on holiday. We also have had speculators, leveraged speculators, who have been mainly concerned about this Evergrande capitulation today. So, you know, we've seen selling on Thursday, selling on Friday. We had the weekend for the news to get even worse. We had selling on Monday.
It is setting up for a turnaround Tuesday. And I would certainly anticipate seeing an initial bounce from today's close through to tomorrow's close as investors, at the very least, take stock, if not a total turnaround. If there's some reassuring noises made from China, It could easily see things reverse.
Perhaps, Evergrande loans are extended. Perhaps, conditions are changed. Perhaps, there's a slight haircut. There's a number of different factors that could come into play. But I think it's very unlikely to see this accelerate much further unless there isn't some further increase in the risks.
- Right. Well, we've certainly seen a lot change in the matter of 24 hours. So we'll be monitoring it closely. Giles Coghlan, chief analyst at HYCM, thanks so much for joining us today.