A 'Contagion' Threat Rattles the Market

A 'contagion' threat rattles the market... The critical 'China story' detail most people are missing... China Evergrande on the brink of default... Overreaction or proper reaction?... A special invitation if you'll be in Las Vegas...

Last week, the Chinese central bank injected $14 billion into the country's financial system...

It's not because everything is going smoothly... In fact, quite the opposite.

We've reported over the last few months about 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...

And now, as our Stansberry NewsWire editor C. Scott Garliss wrote in his daily morning commentary today, 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.

This might sound bad, and it is...

Especially for the Chinese economy in the short term – thus the $14-billion liquidity injection to its banking system. The news contributed to the benchmark S&P 500 Index losing nearly 2% today, its worst daily performance since May.

In Asian trading, Hong Kong equities – as measured by the benchmark Hang Seng Index (HIS) – sold off 3.3%... The Chinese markets are closed for a mid-autumn holiday today and Tuesday, making for an interesting day to come Wednesday.

Evergrande itself lost 10% of its market cap in Hong Kong trading...

Many market observers are fearing "contagion," or a spread of this deleveraging across global markets... But as Scott explained to me (Corey McLaughlin) over the phone today, the fallout might not be as bad as those expectations.

Scott says that this isn't a "Lehman moment" for China... and, in fact, the result could actually boost U.S. stocks in the longer run...

In any case, this is an important story, and Scott is well-versed in the details, so he'll take over today's Digest from here...

What you need to know starts with a critical part of the 'China story' that most people are missing...

The media has portrayed China's actions as the country that's cracking down on technology companies... But that's only partly true. In reality, it has been going after the bad lending practices of those businesses' financial arms.

Take Chinese tech giant Alibaba (BABA), the Asian Amazon, for example...

Through its Ant Group arm, the company facilitated around $230 billion in loans to more than 500 million people in 12 months, according to the Wall Street Journal. That comprised about 20% of China's short-term lending debt.

The lending standards were based on Ant's proprietary scoring system. However, the company was unwilling to share the scoring system with its bank partners. In fact, it's unclear whether the ranking skirted the PBOC's traditional scoring system. Furthermore, the loans had high interest rates... with Ant collecting almost half of the fees but leaving banks on the hook for most of the risk.

Similar themes have played out for the gambling, online education, and securities sectors. The government is worried these industries are fueling too much leverage across large sections of the economy. So, it's putting regulations in place to stem the tide.

This could be dwarfed by issues at real estate developer Evergrande, though...

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.

But recently, the company announced it's struggling to meet its goals...

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 $83.5 million worth of bond payments due on Thursday...

Then there's $47.5 million scheduled for September 29, just six days later.

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.

Already, Wall Street money managers and traders are worrying...

They're looking at things like iron ore... It's used in steel production, which would slow if the real estate market in China takes a huge hit.

And the situation could weigh on copper because it's used in things like pipes and wiring for electrical appliances.

The service sector would get hurt the most because individuals will spend less on items like dining out. To save, they'll eat more meals at home.

But here's the thing... The government in Beijing doesn't want to hurt the manufacturing sector. The industry is the lifeblood of the Chinese economy. It wants to do all it can to protect it. In reality, this isn't a "not too big to fail" situation.

A lot of these moves could actually help the manufacturing sector... Let me explain how.

If Evergrande has to hold a fire sale of its assets, Beijing would allow it to happen. The government would use the company as a precautionary example to others with regard to taking on too much debt.

China's government is cognizant of the implications for commodity prices, like those mentioned above, if the world thinks growth there is slowing. Premier Li Keqiang said the government will use policy tools to stabilize prices (aka, lower costs). This has been a missive since the middle of the year.

Beijing is happy for institutional money managers to start dumping growth-related commodity investments like iron ore and copper. There will be a flight to safe havens like the dollar. That will in turn weigh on the yuan.

By doing that, it would have a two-fold impact... A cheaper yuan would make it easier to sell Chinese goods abroad. Lower commodity prices would bring down the cost of manufacturing and aid the Chinese consumer.

And here's where the payoff comes... A stronger dollar would help the U.S. inflation outlook, meaning the Federal Reserve could go slower on its expected "taper" of asset purchases and wait longer to hike rates, making it easier to service our own massive debt here... It's a long but conceivable sequence of events.

For now, though, China's government is trying to wring excessive debt out of its financial system...

And even though U.S. companies have limited exposure to Evergrande – according to FactSet, investment giant BlackRock has some holdings in the company, and investment banks Goldman Sachs and JPMorgan have small positions too – investors are worried about contagion in the markets...

In China, the Politburo – the communist policymakers – are worried too many companies and individuals are over-levered. They're cracking down on various industries to limit access to risky borrowing and the issuance of loans that people can't afford.

From a long-term perspective, that's good for the growth picture. Yet, from a short-term perspective, it hurts and creates fear... especially considering the long bull market run we've been on since March 2020.

Given that, there's an impetus for Wall Street investors to cut risk exposure. As I write, the benchmark S&P 500 Index and tech-heavy Nasdaq Composite Index are down roughly 4% from their all-time highs.

Investors are unsure of what's transpiring. And rather than be caught holding the bag, they are, as I learned from my 20 years working on Wall Street, "selling first and asking questions later." This might not be the best course of action... Stay tuned.

Finally today, a note about our Stansberry Conference...

We're inching closer to our annual Stansberry Conference & Alliance Meeting, which is back in person this year... and we're thrilled about it.

After a fully "virtual" event in 2020, this year our editors, special guests, and attendees will again gather in Las Vegas... at luxurious Encore at Wynn... from October 25 to 27.

As usual, we will bring together some of the brightest investing minds in the world –including (just to name two) Allianz Chief Economic Adviser Mohamed A. El-Erian and Market Wizards author Jack Schwager – who will share their biggest insights, opportunities, and concerns about the economy and markets today.

Tickets are no longer on sale for the event, but if you're going to be in Vegas, we want to make sure you don't miss a special opportunity while you're there... that coincides with the event.

Here is our friend and Atlas 400 President Gray Zurbruegg with the details...

Have you ever wondered what it's like to land a Gulfstream jet on an ice runway in Antarctica?

What about attending a private wine tasting at Petrus in Bordeaux... or racing Ferraris through the Italian countryside en route to lunch?

If so, I (Gray Zurbruegg) encourage you to keep reading...

You see, we've done all of that – and much more – with The Atlas 400, an exclusive travel and wealth club. (Want to learn more? Click here to view our latest highlight video.)

And now, I'd like to extend an invitation to Digest readers for next month...

The Atlas 400 is hosting a cocktail party for interested candidates following the first day of the annual Stansberry Conference in Las Vegas on October 25. The meeting will take place in the Eastside Lounge in the Encore hotel at 5:45 p.m.

Please, only come if you're really interested in obtaining a membership. And also know...

The Atlas 400 isn't for everyone.

The initiation fee to join is substantial ($30,000), and our excursions aren't cheap. But if you're in a position to enjoy the fruits of your labor, I urge you to join us for cocktails and get to know our group better.

This is the only opportunity that candidates have to speak with current members, ask questions, and briefly experience the company of the world's most accomplished and interesting people.

Imagine traveling the world, enjoying new friendships, taking new adventures, discovering tremendous new opportunities... and perhaps seeing your life and yourself in a whole new way.

If you'd like to join us at the Eastside Lounge... please contact me via e-mail at gzurbruegg@theatlas400.com or by phone at 410-864-0878.

Tax Hikes Will Kill the Bull Market

Todd "Bubba" Horwitz, founder of bubbatrading.com, agrees 100% with a recent Goldman Sachs report that says tax hikes, not a slowing economy, will kill the ongoing bull market in U.S. stocks. He tells our editor-at-large Daniela Cambone why...

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 9/17/21): Asana (ASAN), OptimizeRx (OPRX), Thermo Fisher Scientific (TMO), and Viper Energy Partners (VNOM).

In today's mailbag, feedback on our colleague Dan Ferris' latest Friday Digest... Let us know your thoughts with an e-mail to feedback@stansberryresearch.com.

"Dan, I first read the Avoid News white paper in July 2010 and decided to try it for one month. It's now 11 years later and I haven't watched the news and I haven't missed anything that matters.

"I think more clearly, I am able to focus, and as a medical device engineer, I have invented several new devices that have made a difference in the lives of others that I believe never would have happened if I had been checking news feeds instead of solving real problems.

"Great advice!" – Paid-up subscriber Brian D.

"Dear Stansberry, Thanks for all you do to help investors!

"Regarding the email 'The Curtain Always Drops on the Kabuki Play' by Dan Ferris, I highly recommend that you provide an analysis of the consequences to investors of BlackRock's Going Direct plans with the Fed. It seems the Fed circuit money machine is now tied directly to the market via privileged selected entities. I refer to John Titus's reports. This is new. There must be some kind of indicator(s) to capture this new phenomenon. So much money! Where is it going!? Who is getting it?" – Paid-up subscriber Gary F.

"Enjoyed your article. Back in 2009 I had the pleasure of directing and acting in my play Bubble Money. It was produced at the Players Club in Detroit. Bubbles, the economics clown, figures out that, "If you can lose all your money when the dot-com bubble goes burst and lose it all again when the real estate bubbles goes burst, we just make bubbles money and all the problems go away."

"We had great fun blowing bubbles on stage in this eerily prophetic play. I then proceeded to write five more episodes, finishing with Bubblepocalypse last April." – Paid-up subscriber Mike M.

All the best,

Corey McLaughlin and C. Scott Garliss
Baltimore, Maryland
September 20, 2021