By Laura Frost, Investment Director at M&G Investments
Financial markets have been remarkably resilient so far this year after the turbulence of 2020 and with uncertainty still abounding. Here are seven scary charts to wake investors from their slumber.
1. Evergrande’s current liabilities are almost 2% of Chinese GDP
Global bond markets were spooked recently as, in mid-September, China’s largest real estate company Evergrande showed signs of weakness. Highly leveraged, and with various bonds maturing before the end of the year, the news sent shudders through the market.
Even though markets outside of Asian HY seem to have suffered no contagion as yet, it is scary to note that Evergrande’s liabilities are almost 2% of Chinese GDP. To put this into context, Apple’s current liabilities are 0.5% of US GDP ($107.7bn current liabilities vs 21.4trn US GDP).
This prompted the PBoC to intervene and make it clear this would be a contained event. Looking at the roll off of Asian housing stocks, here is a scary reminder that bonds can still be highly volatile instruments, even when the central bank offers a supportive hand. If the PBoC decides not to support Evergrande and the real estate sector going forward, we will likely see more violent moves down as defaults start to stack up. Thus far the year-to-date fall in the Asia Real Estate HY index below is 30%.
2. In 2020, the market differentiated between sectors – not so this year
Elsewhere in bond markets, valuations are looking very tight. Looking below the surface in European credit markets, there is also surprisingly little spread between valuations of different sectors.
In the height of the Covid sell off of March 2020, the market clearly differentiated between sectors. Within Euro industrials, unsurprisingly those industries most sensitive to a deteriorating growth outlook (autos, energy and basic industry) significantly lagged the Euro corporate bond index (white line). Meanwhile, the industries that proved more resilient were those likely to benefit from lower rates (utilities), greater demand for health services (healthcare) and those aiding a shift to new ways of living and working (technology).
Now, with credit spreads having ground slowly tighter all year, the market doesn’t seem to be differentiating that much at all, with dispersion in this case having decreased five times over. A sign that credit markets are getting too complacent? Or justified in a low default environment? It is certainly scary to see how far we have come in valuations with Covid uncertainly still there.
3. A strange recession: labour pressures at multi-decade highs
One of the scariest things bond investors have had to contend with this year has been the risk of a return of inflation. While few expect double-digit inflation ahead, there is a risk we could see some persistently higher inflation prints than we’ve been used to over the past decades.