What investors are saying about China's regulatory crackdown

Macrolens Chief Strategist & Managing Principal Brian McCarthy joins Yahoo Finance's Alexis Christoforous to break down the latest market action in China.

Video Transcript

- China's regulatory crackdown has sent overseas stocks spiraling downward. Joining me now is Macrolens Chief Strategist and Managing Principal Brian McCarthy. Brian, welcome to the show. Thanks for being here. Lots of news coming out of China today. So glad you're with us. And I want to start with Evergrande, the real estate developer in a lot of trouble there in China. I know that shares were halted earlier in Hong Kong pending some news. There was talk that there might be a takeover bid for the company. What are you hearing?

BRIAN McCARTHY: Sure. So it looks like the news overnight was related to a bid for 51% stake in Evergrande's property management business, so taking care of the buildings they have built, which obviously somebody is going to need to handle in an ongoing manner after Evergrande is effectively dissolved, which is what we're seeing take place. About $5 billion to put that in perspective. Their total debt is around $300 billion.

But there was other news over the weekend, which is interesting as well. A bond popped up from an entity called Jumbo Fortune, which had engaged in a joint venture with Evergrande and claims that Evergrande has guaranteed this bond that missed a coupon payment today, it sounds like. This bond was not on Evergrande's balance sheet.

And there was another medium-sized developer called Fantasia that had a similar experience today. Was also suspended in Hong Kong where a bond that they had guaranteed is-- is going to default. And this guarantee is nowhere to be found on their financials apparently. So you know, the Evergrande problem is big.

It's only going to get bigger as it evolves because we're just going to find that the-- the accounting is-- is not-- not robust in China, as we all know. So again, $5 billion probably coming in, in terms of an asset sale. It is their most liquid saleable asset. So that's great. But this is a drop in the bucket.

- Wow! All right. So then talk to me about the tentacles this thing has. Is this the beginning of the end of the real estate development boom in China? And do we have to worry about the effects of that here on our shores in the US?

BRIAN McCARTHY: Yes, I believe it is the end of the real estate boom in China. I'd say, investor sentiment over the last month or so has morphed from expecting some kind of bailout to now this sort of the optimistic spin-- spin is that they're going to ring fence the situation. If by that we mean they're not going to allow banks to withdraw credit from the system willy nilly and cause a Lehman-like collapse in credit, then yes, the ring fence it to that extent.

But you have maybe as many as 1,100 developments, it now appears in China, in various state of disarray. Evergrande's business has come to a halt. Suppliers want money. Buyers want the apartments that they've paid for. I don't think this is ring fensinble in terms of its effect on the Chinese real estate market.

So this is the bell ringing to speculators in China telling them OK, it's over. Xi Jinping means it when he says houses are for living in, not speculation. And I think the-- the sentiment Humpty Dumpty is-- is going to break that's going to be in a way that's very difficult to put together, I think.

In terms of ramifications for the US, you know, I've been listening here, great segment regarding the supply chain issues in the US. The Fed may be tweaking in a more hawkish direction. And I think it's important to note that the situation in China is related in a reflexive way.

So China's monetary policy is there's a restrictor plate on Chinese monetary policy, which is the managed R&B exchange rate. So when the dollar's really easy and global liquidity is really easy, China has plenty of flexibility to try to deal with something like a real estate bust. So when they made this decision to prick the bubble finally, they did it under the assumption that global liquidity conditions were going to be really easy, the dollar was going to be weak and they had room to deal with it.

If we get a Fed that is forced into tightening more quickly than they had wanted to because of transitory inflation that's proving not to be transitory because of these supply issues, and you see the dollar continue to strengthen as it has started to do in recent weeks, then we need to-- then we need to assess China's ability to deal with its real estate fallout in that framework, which is going to be much more difficult. So these-- these situations or these supply chain in supply-driven inflation in the US, its effect on Fed policy and how China can and will try to deal with the fallout and its real estate market are related in a way that it-s self-reinforcing. And I think this is the negative undertone to these markets we're seeing recently.

- And Brian, today we saw the Biden administration unveil his policy with China or at least his trade policy with China. It looks a lot like the Trump policy. They're going to keep those tariffs on a number of different Chinese imports as they try to have China make good on those phase 1 promises. How should investors think about positioning their portfolios with so much uncertainty still now in a new administration swirling around trade and China?

BRIAN McCARTHY: Right. Well, the speech was billed as revealing the Biden administration's trade strategy. I didn't really see one. You know, there was a declaration that China is not meeting its commitments with regard to the phase 1 deal, which everybody is aware of. There was a threat of frank discussions in response.

But we didn't really get anything more than that. What we did get from US territory and from quotes from unnamed officials in the press this morning was an acknowledgment again, that-- of something everybody knows, which is China is not changing. So we're not going to change their behavior.

China's message is very clear, we're going to do what we do. If you want to decouple, try it and see how you like that. So they're taking a very tough line. This is a very difficult situation for the Biden administration to try to deal with, particularly when we already have widespread supply chain problems globally. So the global economy and the Fed, they need a decoupling threat to global supply chains like-- we need this like we need a hole in the head right now.

So the US doesn't really have a lot of leverage to respond. And it's really unclear that they have any plan for what to do next. So I think this is something that by necessity will be-- markets will be OK with because I just don't really see the Biden administration having enunciated any clear next steps. And I think there's just going to be a lot of talk and a lot of punting on this issue.

- All right. Decoupling may just be our next big buzzword. Brian McCarthy of Macrolens. Thanks so much for being with us.