China was the growth engine for the world. The largest real estate company in the world is in trouble. China’s largest developer, Evergrande, is on the brink of default, and China is allowing it to fail. Xi is taking a hard line. Evergrande had debt due last week and didn’t pay it and entered a 30-day grace period that it must use to meet obligations for foreign creditors.

Recall all of the ghost cities? They remain ghost cities and the capital behind them is now facing defaults.

 

 

 

Who are the largest holders of Evergrande bonds?

 

 

Further, China’s geopolitical relationship with the U.S. has changed. Tensions are high ranging from the SEC’s position on Chinese financial transparency to war games in the South China Sea. Hong Kong has bent the knee. Is Taiwan next? That’s a hard line in the sand for the U.S. and its allies.

The regulatory “crackdown” by the Chinese communist government across a sweeping variety of industries in the country in the name of “common prosperity.”

New policies designed to hamstring “monopolistic” practices – targeting everything from the country’s giant for-profit tutoring industry to video game addiction – and the uncertainties about these regulations have combined to wipe out $1.5 trillion in value from Chinese stocks.

One of the largest real estate conglomerates in China – a company called China Evergrande (EGRNF) – appears to be on the brink of defaulting on $300 billion in debt.

Even worse, the Chinese government and the People’s Bank of China (“PBOC”) sound like they are prepared to let it happen. In fact, the state-run media outlet Global Times warned Evergrande not to expect a bailout and that it shouldn’t assume it’s “too big to fail.”

That phrase, all but assuredly written for this purpose, brings to mind the collapse of Lehman Brothers and auto industry bailouts amid the financial crisis of 2008 and 2009 here in the U.S.

Many market observers are fearing “contagion,” or a spread of this deleveraging across global markets.

The PBOC has warned Evergrande that it needs to bring its debt levels under control while not triggering a real estate crisis. Evergrande owns more than 1,300 developments throughout China. As a result, its assets are worth more than $350 billion.

According to Bloomberg, it generated $73.5 billion in revenue last year and is on track to generate $79 billion this year.

However, Evergrande has expanded into non-traditional business lines as sales growth slowed elsewhere. Some of its new ventures include electric vehicles, bottled water, and insurance. The financing of these ventures caused its debt load to swell from $25.1 billion in 2014 to $110.6 billion today. And its total liabilities are estimated to be $306.3 billion.

Last year, Chinese regulators introduced caps on debt ratios. Evergrande is working to meet those requirements by the end of 2022. It’s trying to sell assets and spin off business units in order to pay down its debt.

The company revealed making late payments on commercial paper obligations back in June, Reuters reported. And with the recent statement about being unable to reduce debt, investors are worried about the potential fallout.

It’s estimated that more than 250 banks and non-financial institutions have exposure to China Evergrande’s loans. (In the U.S., direct exposure is relatively limited, a good thing.)

Regulators are said to have approved a renegotiation of payment deadlines by Evergrande with its creditors. This suggests they’re worried about the company’s ability to meet its obligations.

And if it fails to do so, it could have a domino effect on China’s debt and property markets. Those bond and loan investors could be facing write-downs unless the government bails them out.

Evergrande has $83.5M worth of bond pyments due last Thursday, which they didn’t pay, and another $47.5M scheduled for September 29th, just 6 days later.

Last week, the Chinese central bank injected $14B into the country’s financial system. The added liquidity injected into the market last week – through one- and two-week investment vehicles – and regulatory actions are a clear sign that the Chinese government is worried about the country’s debt load.

 

 

There are estimates that China has a debt-to-gross domestic product (“GDP”) ratio of 300% or higher. For context, the U.S. debt-to-GDP ratio is just over 100%.

The question now is… How far will the government go to stave off a broader fallout within the economy?

Evergrande employs some 200,000 people and reportedly hires another 3.8 million annually for different projects.

If Evergrande fails, it won’t be the only domino within China’s financial system to do so. All of the institutions involved will take a hit. They’ll all have less money available to lend because their balance sheets will thin out.

It will mean layoffs across the board. The change would turn into diminished demand for all types of goods and services. Reduced profits and less available money to spend could spiral downward and downward.

And while this mostly seems like a domestic problem for China, it’s never that simple. It’s the world’s second-largest economy, so the dominos could fall around the world.

Even if the country produces many of the goods consumed elsewhere, it also imports plenty of items. In 2019, exports totaled $2.57 trillion while imports totaled $1.58 trillion.

So, if this situation slows demand from China for trade, it’s sure to impact the economic growth picture across the globe. The situation will hurt domestic demand in China for all types of goods.

 

 

The latest China problem is debt-laden property developer Evergrande, which has missed some payments and, as of today, is in default. There is never just one cockroach. While we don’t know the extent, I will bet you a dollar to 47 doughnuts China has dozens of other “Evergrande lite” problems.

 

Tax Hikes

 

House Democrats spelled out a series of proposed tax increases on Monday, attempting to piece together enough votes for a sweeping spending package at the heart of President Biden’s economic agenda. Under the proposal, tax increases and enforcement would offset up to $3.5T in spending on the social safety net, like Medicare, childcare and a national paid-leave program. Also known as the “human infrastructure” side of a broader infrastructure proposal, the package would increase renewable energy tax breaks and establish a broader climate change policy.

What’s in the bill? The proposal would increase the top corporate tax rate to 26.5% (from 21%) and the top individual rate to 39.6% (from 37%), respectively. Meanwhile, the top federal rate on capital-gains taxes would be raised to 25% (from 20%), and – added to an existing 3.8% surtax on net investment income – the total tax bite would be 28.8%. The bill would also impose a 3-percentage-point surtax on people making over $5M and provide $78.9B in funding to the IRS to bolster tax enforcement for taxpayers earning more than $400K a year.

These aren’t just spending bills, though. They are also tax bills—potentially problematic ones. The House Democratic version includes a provision that would prevent investors from holding non-publicly traded assets like hedge funds and real estate in IRAs. Those who currently have such would get two years to move the assets out of IRA form, at which point, any gains would become taxable.

Getting to $3.5T… According to the Joint Committee on Taxation, the plan includes about $1T of tax increases on high-income households and about $1T on corporations. Democrats intend to generate another $120B from tougher tax enforcement and $700B from drug-pricing policy changes. The legislation also assumes another $600B in revenue from faster economic growth.

The release of the tax details was the last major missing piece in the Democratic economic plan and will accelerate lawmakers’ negotiations over new spending. Republicans are expected to mount unanimous opposition to the proposal (which would reverse the 2017 tax cuts), while Democrats have few votes to spare in the House and none in the Senate. Just last week, Sen. Joe Manchin (D., W.Va.), an influential moderate vote, penned an op-ed questioning the spending package’s effect on inflation rates, budget deficits and overall debt levels.

 

US Economy

 

  • The U. Michigan consumer sentiment index was almost unchanged this month.
  • Longer-term financial situation expectations continue to fall.

 

 

  • The NY Fed’s regional services index showed slower growth this month.
  • Price pressures continue to mount.
  • The West Coast port congestion is at extreme levels as businesses try to rebuild inventories ahead of the holiday shopping season.
  • Consumers’ views on buying conditions for homes continue to deteriorate, according to the latest U. Michigan survey.
  • There are now 72 container ships waiting to unload at the port of LA/Long Beach, a new high.
  • Manufacturers expect disruptions to ease within the next six months.
  • Housing prices remain elevated

 

 

  • Since the beginning of 2021, the cost of transporting an industry-standard, 40-foot container to the northeast U.S. from northern Europe has more than tripled – from just over $2,000 to nearly $7,000.
  • From China, the price has quadrupled to $22,000 per container.
  • A lopsided trade relationship leads to empty containers headed to China. Over the first seven months of 2021, with the vast majority of trade in containers, the U.S. imported $270 billion worth of goods from China… while it exported less than one-third of that sum to China.
  • Around 75% of containers leaving the Port of Los Angeles don’t have anything in them.
  • The 5-year Treasury yield hit the highest level since the start of the pandemic as the market prices in faster rate hikes and taper.
  • Initial jobless claims were higher than expected last week.
  • Household net worth continues to surge
  • However, US households’ view of their income and personal finances has been deteriorating.
  • According to Markit’s flash PMI report, growth in business activity moderated further in September.
  • The Kansas City Fed’s regional manufacturing report supports the trend we see from Markit PMI
  • Supplier problems (many related to import bottlenecks) have been getting worse.
  • But manufacturers are upbeat about the future.

 

Inflation

 

Inflation is assured, according to many analysts, in part because wages are growing so fast. But are they? Certainly some industries and occupations are seeing higher compensation. But in inflation-adjusted “real” terms, the average US worker actually lost purchasing power in the last year.

 

 

 

Real average hourly earnings decreased 0.9% in the year ended August 2021. Hours worked didn’t change, so average weekly earnings fell, too. Of course, the wage data only applies to people with jobs, and millions still don’t have them. Both wages and the inflation by which they are adjusted to real wages have significant regional variation, too. But for the moment, typical workers still aren’t getting ahead. That’s a sign of stagflation, not inflation.

Speaking of inflation, here’s a long-term look that helps illuminate exactly where it’s been a problem, or not. The red bar shows major energy price growth since 2000. This feeds into two of the eight CPI components: Housing and Transportation. Both had significant price growth in this period.

 

 

Medical Care grew even more. College Tuition and Fees also shot higher, adding to the personal inflation rate of anyone paying for their own or their children’s higher education. If you managed to avoid energy, healthcare, and education spending, inflation probably hasn’t been a severe problem for you. Easier said than done.

 

 

Market Data

 

  • The S&P 500 is dipping below the 50 DMA

 

 

  • For the first time in many months, the S&P has suffered consecutive closes below its 50-day average. At the same time, fewer than 60% of securities on the NYSE have held above their 200-day averages, ending one of the longest streaks in history.
  • High-dividend/dividend growth stocks have been underperforming
  • The Dow has sharply underperformed the S&P 500.
  • Only 31% of S&P 500 members now trade above their 50-day moving average.
  • Share buyback activity is surging again.

 

 

  • The People’s Bank of China issued a blanket ban on all crypto currency trading Friday, declaring all forms of digital transactions and financing as ‘illegal activities that are strictly prohibited”.
  • 80% of S&P 500 stocks are down 10% or more and only 38% of Nasdaq stocks are above their 200-day moving averages.
  • Total margin debt at the end of May 2021 reached a record high of $861.63 billion. Three months later, it reached $911.55 billion. This represents a record high in margin debt relative to GDP.

Total domestic debt is the total outstanding debt owed by all domestic sectors (households and nonprofit institutions, financial and non-financial corporations, farms, state and local governments, federal government) and includes government bonds, corporate bonds, bank loans, other loans and advances, mortgages, and consumer credit.

Total Domestic Debt as a Percent of GDP – data as of 3-31-2021 (select countries) Source: Ned Davis Research (NDR)

 

 

  • Declines in kindergarten enrollment in 2020:

 

 

Thought of the Week

 

Twas battered and scarred, and the auctioneer
thought it scarcely worth his while to waste much time on the old violin,but held it up with a smile;

“What am I bidden, good folks,” he cried,
“Who’ll start the bidding for me?” “A dollar, a dollar”; then two!” “Only
two? Two dollars, and who’ll make it three? Three dollars, once; three
dollars twice; going for three..”

But no, from the room, far back, a gray-haired man came forward and picked up the bow; Then, wiping the dust from the old violin, and tightening the loose strings, he played a melody pure and sweet as caroling angel sings.

The music ceased, and the auctioneer, with a voice that was quiet and low, said; “What am I bid for the old violin?” And he held it up with the bow.
A thousand dollars, and who’ll make it two? Two thousand! And who’ll make it three? Three thousand, once, three thousand, twice, and going and gone,” said he.

The people cheered, but some of them cried, “We do not
quite understand what changed its worth.”

Swift came the reply:

“The touch of a master’s hand.”

And many a man with life out of tune, and battered and scarred with sin, Is auctioned cheap to the thoughtless crowd, much like the old violin,

A “mess of pottage,” a glass of wine; a game – and he travels on. “He is
going” once, and “going twice, He’s going and almost gone.” But the Master comes, and the foolish crowd never can quite understand the worth of a soul and the change that’s wrought by the touch of the Master’s hand.

Myra ‘Brooks’ Welch

 

Picture of the Week

 

 

 

 

All content is the opinion of Brian J. Decker