Bubble Bubble Toil & Trouble: A Focus On Market Bubbles

Are asset prices too high and markets in a bubble that is ready to burst at any time?

There have been speculative manias for as long as human beings have been allowed to speculate en masse. US Housing, Dot Com, the South East Asian Tigers, Japan, the South Sea Bubble, Dutch Tulip mania… the list stretches on through financial history.

What do all these episodes have in common? People. The objects of speculative mania have changed, the century in which they have taken place has changed, but people haven’t.

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Evergrande Update 2: Is The Contagion Spreading?

How will Evergrande's default affect other markets?

Evergrande is back in the headlines after a few weeks out of the media spotlight, with scrutiny being shifted to fellow developer Kaisa instead. Unfortunately, the period of calm seems to have ended, with Evergrande reported to have finally failed to make coupon payments at the end of a 30 day grace period. How are markets currently pricing the potential for widespread contagion?

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Evergrande Update 1: Is The Contagion Spreading?

How will Evergrande's default affect other markets?

Over the past three weeks or so, Evergrande has, after missing initial deadlines, managed to meet interest payments on its debt within the 30 day grace period. As such, it has so far managed to avoid a formal default. However, as headlines over the past few days attest, the contagion, initially contained within the real estate sector, has begun to spread to other parts of the Chinese markets.

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How Can Evergrande’s Contagion Occur? 4

How will Evergrande's default affect other markets?

The series of events described in parts 1 to 3 of these articles about Evergrande’s unfolding saga represent one of the worst case scenarios, if not the worst case scenario. Chinese authorities can intervene at any point in the sequence of events, which will naturally alter the course of future events. However, where and when they choose to intervene is of critical importance.

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How Can Evergrande’s Contagion Occur? 3

How will Evergrande's default affect other markets?

As the Evergrande contagion spreads via the Chinese banking system to the rest of the economy, the uncertainty will lead to a squeeze on USD funding across the board. Which is when, and how, the contagion has the potential to spread across the world, not forgetting that Chinese real estate developers would have at this point already defaulted on a good chunk of their Dollar borrowings.

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How Can Evergrande’s Contagion Occur? 2

How will Evergrande's default affect other markets?

As the Evergrande induced contagion spreads, banks and other financial institutions will be forced to write down the value of their investments across the Chinese real estate sector; encompassing loans, bonds, exotic financing products (a la the infamous wealth management products), and even shareholdings.

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