Today we are going to talk about things that are back in the headlines. We get a lot of calls and questions from clients, friends, relatives about things in the news. We are surrounded by headlines that are driving levels of fear and anxiety for many.
Headline #1 Evergrande
Prior to three weeks ago, many of us would not have been familiar with Evergrande, which is one of China’s largest real estate developers, and one of the world’s biggest businesses by revenue.
The company made its name in residential property, but also has investments in electric vehicles, food and beverage, sports and theme parks. It has financed much of its growth through debt, and is reportedly over $300 billion in debt.
A couple of weeks ago the company disclosed to investors it could default on some loans if it was forced to raise money quickly. Evergrande has sold some assets to cover loan payments coming due, but many people are concerned that it won’t be able to meet obligations. Rating agencies have downgraded the company’s debt and shares as well. Evergrande trades on the Hong Kong Exchange and are down around 85% over the past year.
At this point, the Chinese government has stepped in to stabilize the housing market. They want to protect the thousands of people who have purchased unfinished apartments, and to protect workers in the housing industry, which accounts for up to 20% of the urban workforce.
If Evergrande were to fail, there would be cascading effects on the Chinese economy. The lending standard would get tougher leading to a possible credit crunch which could lead to more company failures. Investors would likely see the Chinese market as less attractive and might pull their money, resulting in big losses for investors. Since Evergrande has borrowed money from many different lenders, a default could ripple through the financial sector.
Headline #2 Inflation/ Interest rate levels
As a stock market investor, we want some inflation; as a consumer, we do not. It’s a funny equation. Inflation leads to higher corporate earnings given stocks are priced based on the future earnings expectations or cash flows of a company. As an investor, a little inflation means a higher expected rate of return in stocks.
The current inflation rate is approximated to be around 5% whereas the “normal” inflation rate in Canada is around 2%. This could be a period of hyperinflation, but remember, in March of 2020, we didn’t have inflation due to the global economic lock down. In fact, we had three months of deflation. The question now is: is this a period of transitory inflation making up for that period of deflation in 2020 or is this the beginning of a longer-term period of higher inflation?
Central banks monitor and adjust money supply to deal with inflation. The general target is a 2% rate of annual inflation from those same central banks.
- When Is Inflation Good?
When the economy is not running at capacity. This generally means there is unused labour or resources and inflation theoretically helps increase production. More dollars translate to more spending, which equates to more aggregated demand. More demand, in turn, triggers more production to meet that demand.
- When Is Inflation Bad?
Inflation erodes purchasing power, or how much of something can be purchased with currency. Inflation erodes the value of cash, so it encourages consumers to spend and stock up on items that are slower to lose value. It lowers the cost of borrowing and reduces unemployment.
- How does this equate to current interest rates? The Bank of England has told the market to brace for some interest rate hikes. It’s thought that they may do this because inflation is running around 4% and an interest rate hike will slow things down a little. From a Bloomberg article posted on Oct 12. “A combination of higher energy prices, supply chain disruptions and rising wages in some industries has undercut the BOE’s original view that much of the jump in prices will prove transitory. The central bank last month said it expects inflation to exceed 4% in the last quarter, more than double its target.”
It’s a fine balance that the central banks play in trading off higher interest rates or higher inflation levels. The question remains, even if they raise interest rates, will it lower inflation or will the general economic recovery and a fix in the global supply chain naturally curtail current inflation levels? The answer? Not sure.
For more headlines, including;
-What about interest rates?
-What is going on in the US with the debt ceiling?
-How is the Canadian dollar linked to the price of oil?
-What is the deal with supply chains in the world economy?
Tune in to Episode 74 of The CM Group’s Free Lunch Podcast.
Stay happy, stay safe, stay well!
-The CM Group