The biggest fear investors should have with the crisis gripping overly indebted Chinese real estate developer Evergrande is global contagion, argues Goldman Sachs.
"The danger is precisely the contagion effect, should a default occur without clear 'ring-fencing' of spillovers to other parts of the real economy or financial sector. Events over the past week suggest risks of inching toward that direction," said Goldman Sachs Hui Shan in a research note on Monday.
Shan points out that she is already seeing signs of "contagion" — a word that skyrocketed into financial media lexicon during the Great Financial Crisis when the liquidation of Lehman Brothers pressured all asset markets globally — related to Evergrande.
"Equities and bonds issued by other developers with high leverage have sold off. Protests at Evergrande offices across China may cause reluctance among potential homebuyers more broadly. Financing pressure faced by property developers has contributed to failed land auctions in a number of cities," said Shan.
An initial whiff of contagion blew through U.S. markets to kick off this week's trading.
By early afternoon trading, all major stock indices were at session lows. The Dow Jones Industrial Average plunged more than 800 points. The CBOE Volatility Index (VIX) spiked to levels not seen since May.
U.S. companies with outsized China exposure such as Apple and Tesla sold off hard, and were some of the most actively trafficked ticker pages on the Yahoo Finance platform. The concerns around Evergrande also triggered a nearly 10% sell-off in bitcoin (usually seen as a safe-haven play during bouts of stock market volatility), which spread to shares of crypto mining tech seller Nvidia.
"When something like this occurs, it is hard to get your arms around what it is and what contagion means. Think back to that stuff during the European or Asian financial crises," said Baird strategist Michael Antonelli on Yahoo Finance Live.
Goldman's Shan outlined several potential scenarios for China's economic growth from the troubles at Evergrande, all of which will only stoke fears of contagion to global asset markets.
Explains Shan, "In the first scenario, the total negative impact would depress the level of output by 1.4% of GDP, with the direct impact playing the most important role. In the second scenario, the total negative impact increases to 2.5% of GDP. In the third scenario, the total negative impact is as large as 4.1% of GDP, with the financial conditions channel contributing the most to the total impact, highlighting the importance of the financial spillover effect on the economy in this most bearish scenario. Note that this is a partial equilibrium exercise which does not take into consideration potential monetary and fiscal policy easing in response to the property market declines."
Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.
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