Red Fever

On Monday, September 20th, investors around the world collectively said, "Oh crud."

Everything was down that day — from stocks to crypto to the human spirit (which has been in a bear market since lockdowns began). 

Doomsayers who have been worried about a big looming crash in the market declared victory. Technical analysts, practicing their modern haruspicy, drew some lines on graphs and were still, shockingly, taken seriously.

At the same time, speculators “investors” locked arms, cried out “buy the dip,” and began collectively throwing their money into the blood red sea of the market. 

I didn’t commit to either dogma. 

Instead, I put 10% of my cash reserves into a few dividend-paying funds that were hit hard and adopted a “wait and see” approach before committing any more. 

Why?

This is what I wrote on the DIYwealth Facebook page:

If you're an investor looking to buy the dip, don't do it all at once.

The drop today seemed to be because of fears of Chinese RE developer Evergrande defaulting and concerns about the Fed tapering asset purchases.

China's market is *closed* until Wednesday. That means this selloff is occurring while traders in China WANT to sell. Then the Hong Kong Market is closed on Wednesday. If there's panic selling on Wednesday, what do you think will happen in Hong Kong's market on Thursday?

Plus, the Fed is having its September meeting on Tuesday and Wednesday to discuss a timeline for pulling financial support from the markets.

That means, if you're going to invest, you should probably wait until Thursday or Friday to see how things go... and keep some cash ready if you're feeling opportunistic. 

When the HKEX and SSE are open, expect some panic selling, and expect it to affect US markets too. If the Fed announces that they're tapering asset purchases, expect some panic selling to hit on the exact same days.

This could be an excellent entrance opportunity, if you're feeling so inclined. But only if you go in a pinky toe at a time.

Lots of words in there. Words like “Evergrande” and “defaulting” and “Fed” and “tapering” and “pinky toe.” 

I delved into Fed monetary policy and the concerns about tapering on last week’s post. This concern looks like it’s been put off until November or December.

This week, let’s talk about how and why a Chinese real estate developer caused the U.S. market to shed billions of dollars.

China and the Evergrande Fiasco

Ok, this past week you’ve probably heard lots of talk about China and something called Evergrande.

China, if you didn’t know, is a country. Evergrande is the second largest real estate developer in China. 

Evergrande built lots of office buildings and apartments, many of which sat unoccupied. (Have you seen pictures of China’s uninhabited ghost cities? It’s bananas!)

To raise this money, Evergrande borrowed from a lot of Chinese investors and institutions around the world. They promised to pay guaranteed yields of 12% (about the same yields that Bernie Madoff promised the people he bilked). They gave individual investors gifts, including air purifiers and Gucci bags. 

[FINANCE DADDY PRO-TIP: Guaranteed returns are a red flag, warning you to stay away.]

Evergrande in total borrowed $300 billion. Evergrande doesn’t have the cash to pay interest on this debt. So… it didn’t pay. 

Last Monday, investors made this face:

Over the next 30 days, we will know if this company will default on its bonds. (A “bond default” just means the borrower missed a debt interest payment.)

In the meantime, the Chinese government is scrambling to save face and help local governments, which according to the Wall Street Journal, “have been tasked with preventing unrest and mitigating the ripple effect on home buyers and the broader economy, for example by limiting job losses.”

For now, just for now, the situation seems somewhat contained. But this is still an evolving story. (Check out Patrick Boyle’s excellent videos on the subject for a deeper analysis of what’s happening with Evergrande and why.)

So why should you care? And why did this cause people to panic last Monday?

The answer: Contagion, but not the Covid variety.

When lots of debt goes bad, the lenders of that debt lose money. When lenders lose money, they stop lending so much or, worst case, go bankrupt themselves. 

That means they can’t pay their own debts, and other institutions begin to go bankrupt. Investors in those institutions lose some or all of their money. Small businesses can’t get loans. People jump out of windows. It’s a bad time. 

This is an oversimplified description of what happened in 2008. 

With Evergrande, I doubt it will be this bad. 

Back in 2008, the damage of huge debt defaults spread through the economy like a wildfire through brush.

With China, it’s hard to say if Evergrande will be a spark that burns through their economy, and whether this fire could hop over to the U.S. as well. 

For instance, the amount that U.S. investment firms have at risk in Evergrande is large, but not devastatingly so.

But if Evergrande’s contagion spreads to, say, Chinese manufacturers? 

All of a sudden, American and European companies will have even more supply chain issues, and the wildfire begins to spread in the West, too.

But again, for now, the situation looks ok. And then last week, on Thursday morning at 8 A.M., I wrote that the current situation was short-term bullish for the markets.

The market went on a huge positive run. The Dow was up 500 points. The S&P 500 was up 1.2%. The Nasdaq was up 1%. 

I expect this to continue for the time being. 

After all, the Fed is still flooding the markets with cheap loans, and big companies are packed with so much cash they don’t know what to do with it.

I would not be surprised if we saw new all-time-highs in the market before the end of 2021. 

So if you were looking to deploy some of your cash in the market? 

Dip a pinky toe in. 

Right now the Schwab US Dividend Equity ETF (NYSE: SCHD) looks like a safe, low-cost way to get some appreciation and earn some income, if you’re willing to hold it long term.

But remember, so long as you’re investing, as long as your wealth is compounding, there’s never a rush to go “all in” or “sell everything.” You can just… wait and see.

Someday soon there will be a reckoning, probably when the Fed begins to slow down its bond buying and sell some of the assets it’s accumulated. In two weeks, I’ll explain how to prepare for that. 

Next week I have something special planned.