by Ivan Martchev

November 16, 2021

The deficit spending that supported the economy in 2020 is showing up in hot inflation numbers in 2021. Combined with bottlenecks – because it is harder to reopen a global economy than it is to shut it down – you see what a 35% surge in M2 money supply does to the Consumer Price Index numbers. Consumer Price Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

While I do think that this is directly related to 2020 government policies to keep the U.S economy from falling into a depression, whoever is in power in 2021 will have to pay for the inflation surge, come election time. Democrats lost the Virginia gubernatorial race and barely hung on to New Jersey. While I think the inflation numbers will get better in 2022, I do not believe they will get back to pre-pandemic levels because of owners’ equivalent rents and wage gains in the CPI. This creates a perfect storm for the Democratic Party in time for the mid-term election less than 12 months away. It would be impossible to tell the American public – as well-intentioned as it might be – that large government spending on human infrastructure is reducing inflation in the future when the CPI gains are at a 30-year-highs right now.

There were some swings in stocks due to the hot CPI releases, but the swings in the bond market were truly horrific. We declined below a rising 50-day moving average on the 10-year Treasury yield the day before the CPI release, and we violently rose above it when the 6.2% inflation number hit the tape. CBOE 10-Year Treasury Yield Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I am puzzled that Treasury yields declined as much as they did in November, going into the Fed taper announcement (reduced bond buying starts officially this week), but with increased tapering in December and more bad inflation coming, I think we will see the 10-year Treasury yield soon rise above 1.70%.

There hasn’t been much trading above 1.70% so far in 2021. Bonds are known for momentum moves when the market is leaning the wrong way and needs to right itself, but I still think the probability of seeing a 2% print on the 10-year by the end of the year is very high.

China’s Slowdown Isn’t Only About Evergrande

There are several Chinese real estate developers missing their bond payments, so this distress goes well beyond Evergrande. The Evergrande Chairman has pledged yachts, jets, and mansions to make bond payments, but he does not have the personal fortune to roll over bonds coming due in 2022.

Either he gets a bailout from the Chinese government or Evergrande goes under.

Which one will it be?

Debt Distress Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The issue is that bailing out Evergrande also means bailing out these smaller developers. Will Xi Jinping come to the rescue of them all? Xi cannot afford a collapse in the Chinese real estate market at a time when he is about to solidify his position as “President for Life,” which gets finalized exactly a year from now in November 2022. Either the “three red lines policy” needs to be revised, or Xi risks not getting confirmed for a third term as President.

What are the three red lines? They are policies that amount to forced deleveraging for fear that a fast debt build-up in the real estate sector will crash the economy either in a Japanese 1990-style or the U.S. in 2008. The problem is that deleveraging itself can pop the real estate market bubble, however well-intentioned, as there is no guarantee it works in an orderly manner if Evergrande or more developers fail.

As they stand right now, the three red lines cut off access to financing if the liability to asset ratio (excluding advance receipts) is more than 70%, net gearing ratio is more than 100%, and cash to short-term debt ratio is less than one. Basically, overly indebted real estate developers in China, of which there is more than one, cannot borrow more money in order to operate, as things stand now.

The way I see it, either the Chinese government guarantees new loans in order to stretch out deleveraging over a longer period of time or Xi Jinping might get thrown under the bus by the Politburo standing committee come November 2022.

Navellier & Associates does not own China Evergrande Group (EGRNF), in managed accounts.  Ivan Martchev does not own China Evergrande Group (EGRNF), personally.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

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About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev

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