Evergrande and the Chinese markets


FFrom last Monday’s peak in volatility, large-cap equity markets rebounded to the point where they closed the previous Friday. As we wrote in last week’s update:

“Most of the time, a spike in volatility from an extremely low level of volatility will revert to a normal bull market environment. It looks like a sleeping person getting hit with a glass of cold water: they wake up surprised and take a few moments to assess their surroundings. The market has just been hit with a glass of cold water and it will take some time to gauge where it wants to go next. “

There could be an increase in volatility around the corner, no one can really predict that, but at the moment the market appears to be trying to get back to normal after its singular day of decline.

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What drove the markets continues to lead

As of Friday’s close, Canterbury’s risk-adjusted industry ranking was as follows: healthcare, real estate, technology, discretionary, communications. With the exception of Consumer Discretionary, which has fluctuated all over the rankings list thanks to volatility from Amazon and Tesla (its two most important components), those rankings have remained consistent. Real estate has been at the top of our lists throughout the year. Technology and communications, as well as healthcare have been strong outside the first months of 2021.

How long will this continue? Canterbury’s rankings are risk-adjusted and are not solely based on performance. The ranking indicator takes volatility into account. For example, if sector A has a volatility of 80 and sector B has a volatility of 40, then sector A would have to perform twice as much as sector B to be in the same position on the ranking list. Generally speaking, this allows us to compare all asset classes on an equal footing.

This is where volatility in technology and related industries can come into play. As of this writing, Monday, September 27, there is a single day of leadership reversal. In other words, the long-term leaders are lagging behind and the laggards are at the forefront (again, it’s only a day). If technology experiences an increase in volatility, especially an increase that outpaces other market segments, it may start to lower our risk-adjusted rankings as risk increases, especially if it is downside risk.

China

If you’ve been following the news cycle last week, you may have noticed the news about a Chinese company called Evergrande. Evergrande is a large Chinese real estate developer, one of the largest in the world, and currently suffers from a huge mountain of debt. An article on CNN Business read this Sunday:

The real estate developer’s debt crisis is a major test for Beijing. Some analysts fear it will even become the Lehman Brothers moment in China, sending shockwaves through the world’s second-largest economy. Real estate – and related industries – accounts for up to 30% of China’s GDP.

This week, investors took a whiplash as the company met a critical debt deadline but failed to settle another. Stocks rose one day and fell the next.

— Michelle Toh, CNN Business

Evergrande may shock the Chinese economy, but in terms of market liquidity, Chinese markets have been struggling long before Evergrande became a popular topic in the news last week. Remember that markets are determined by supply and demand and by investor emotions. A chart of China’s large-cap stocks would indicate that supply has greatly exceeded demand over the past 7 months:

Source: AIQ Trading Expert Pro, Canterbury Investment Management

Given this chart and the volatility of Chinese large cap stocks, I would expect Chinese markets to remain volatile. In other words, on a day to day basis, you will see trading days above +/- 1.50%. This is what volatility brings. You will get some really big bear days as well as some big bull days. Just because some days may have a “+” sign in front of them, increased volatility is negative.

Final result

Sectors will continue to rotate based on market strength. Canterbury will continue to monitor the different levels of risk of different securities in the market. An adaptive portfolio strategy, like the Canterbury Portfolio Thermostat, will alternate between different areas with bullish characteristics.

For alternatives to equities, 1x reverse China is a good means of portfolio diversification. According to the shared graph, China has not been a good investment, but the reverse has been. As China continues to experience volatility, its reverse stance acts as a good portfolio diversifier. The objective would be that if the US markets start to experience more volatility, a reverse position would moderate the fluctuations of the portfolio.

Learn more at ETFtrends.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

About Warren Dockery

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