The U.S. stock market has suffered violent swings over the past two weeks as investors digest the economic effects of the global pandemic and Washington’s policy responses.
For the year, the Dow Jones Industrial Average is down about 21 percent, as of March 27. Volatility, as measured by the CBOE Volatility Index (VIX), is as high as it was during the 2008 financial crisis. The VIX ended March 27 at 65.54, more than five times its level at the beginning of the year.
The bond market has arguably suffered even more. While the Federal Reserve’s intentions to buy investment-grade debt offers a respite to high-grade issuers, already overleveraged high-yield borrowers are left in the dark.
Many uncertainties regarding the CCP virus, commonly referred to as the novel coronavirus, remain unresolved. In the short to medium term, downside risks to investors are still high.
Given the market turmoil in the West, the Chinese Communist Party (CCP) hopes it can attract international investors to China.
Despite the CCP’s mishandling and coverup of the virus outbreak, Chinese financial markets have fared relatively better. Markets are down in general, but with less volatility, causing the perception of a safe haven for international investors.
Both the CSI 300 Index and the Shanghai Stock Exchange Composite are down about 10 percent year-to-date, a comparatively mild correction compared to major markets in New York, London, and Frankfurt.
In late February, China’s onshore bond market got a shot in the arm. JPMorgan Chase’s emerging market government bond index began including Chinese bonds with a 10 percent weighting, opening the floodgates for $20 billion of foreign flows into China’s government bonds.
Pain Is Yet to Come
International investors should not be seduced by this. While foreign markets are volatile, rushing into China now would be jumping from the frying pan into the fire.
The perception of China’s calmer markets is driven by two tenuous theories.
One is that the CCP virus has waned inside China, and is now spreading like wildfire across the United States and Europe. The United States has overtaken China with the greatest number of confirmed cases, and that number is yet to peak, with much of the country’s economy on lockdown.
But the actual number of infections inside China is unknown. Both the overall rate of infections and the death rate are likely far greater than the official count.
The other theory is that after a collapse, China’s economy will get back on track. But despite the CCP’s resolve in reopening factories and stores, slumping global demand is unlikely to generate much economic activity. And at this time, Beijing authorities are unlikely to enact massive stimulus measures similar to the ones enacted by the Federal Reserve and the European Central Bank.
Some sectors will especially bear watching going forward.
The Chinese property sector is the backbone of the country’s wealth and most important to the middle class. Even with the semblance of a return to normalcy, the property sector is still deteriorating.
China’s Beige Book property index—a widely followed set of on-the-ground economic data—showed a further decline of sales volumes between February and March, “contradicting the notion that China’s economy is returning to normal, as some official data indicate,” according to a March 24 Financial Times report.
The property sales volume index declined from –38 in February to –49 in March, showing a further exacerbation of the real estate market.
The decline in property sales is especially problematic in China. Many developers are overleveraged and risk defaulting on their U.S. dollar-denominated bonds. Despite the recent publicity of dollar bond defaults by Chinese issuers in 2019, few were property developers.
In the first two months of the year, about 105 mostly small to medium-sized real estate firms filed for bankruptcy in China, according to Bloomberg data.
Another sector facing problems is shadow banking—a group of trust companies, asset management firms, insurance companies, and peer-to-peer lenders that have fueled China’s debt growth in recent years.
Over the past two months, some companies have told customers who bought into their investment products that their promised returns would be cut due to issues with their borrowers.
Weidai Ltd., a company specializing in hard asset financing, recently told customers on its mobile app that it had stopped paying interest to investors, according to a Wall Street Journal report.
Anxin Trust, a trust company that sold so-called high-interest investment products, has pulled its stock from trading and is facing financial restructuring.
Anxin was already in dire financial straits before the CCP virus outbreak. Last April, it had to defer principal payment on roughly 2.8 billion yuan ($400 million) of trust products it sold to customers. The company had an emergency round of senior executive meetings on March 24 and its principal payment in April 2020 may be in jeopardy, according to a Caixin report.
Many of these shadow banks have lent to local projects and small to medium-sized businesses that are cut off from large state-backed lenders. And these projects also happen to be some of the most severely disrupted due to the virus outbreak.
How the outbreak resolves itself—as well as the finances of these firms—remains to be seen.