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U.S. stocks, global markets dive on China property fears

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Daily FX.com Analyst Christopher Vecchio joins the Yahoo Finance Live panel to discuss China's Evergrande default risk.

Video Transcript

- For more on the sell off and what this means in terms of the global story, we want to bring in Christopher Vecchio. He's an analyst with Daily FX.com. And Christopher, it's great to have you. So trying to-- obviously, investors very concerned about what this could mean for global markets. From your perspective, from how you're looking at this, I guess, how major of a global market problem could this potentially be?

CHRISTOPHER VECCHIO: Hey, Sean, and so thanks for having me. You know, this is really arriving at an interesting time for markets right now. It feels like it's a perfect storm. We have the Fed meeting this week, of course, in which we've seen US economic data start to weather the Delta variant concerns, increasing the odds that we do have some semblance of a taper announcement or hint of a taper coming at this Wednesday's meeting.

We're also in the seasonally worse period of the year for stocks. These last two weeks of September, the first week of October tend to be the worst time of the period for US equities. And now, we have this concern coming out of China. Now, it is the mid-autumn festival in China, so policy officials have been quiet even after this weekend in which Evergrande problems seem to have deepened.

But right now, when you look at what's going on in the Chinese bond indices, it appears that this is still contained to the real estate sector or those sectors adjacent to the real estate sector. We've seen Sinek group, those shares are down about 87% today before being halted. Sinek has seen its bond yields rise by several basis points in recent days. And, of course, Kaiser group, apologies if I'm mispronouncing any of these names, those have seen some additional pressure as well.

Financing groups like Fortune Star, that has seen its bond yields go up as well. But when you look at other Chinese names like Lenovo or Bank of Communications, we're not talking about that much significant pressure here. So right now, these Chinese concerns, the lack of commentary from Chinese officials arriving ahead of this Fed meeting in which a taper is anticipated, it's giving some investors here in the United States some jitters.

- Well, yeah, understandably Christopher. Let's roll back the clock a little bit and help us understand what's different about a potential collapse of a Chinese property giant versus what we went through in 2008. And I'm thinking back to Ben Bernanke's comment of March 2007 when subprime mortgages here in our country started to blow up. And he said, don't worry, no contagion. Not an exact quote, but that's essentially what he said. No contagion. So why this time with China, should we feel that there's no contagion? Because that's what we keep hearing.

CHRISTOPHER VECCHIO: So there's two different issues relative to the 2008 episode. First and foremost, China's property sector is actually twice as large as the United States is at the time that Lehman Brothers went under. But with respect to what Ben Bernanke said about contagion back then, subprime mortgages were packaged and sold all over the world, whereas Chinese property debt really is more insular to the Chinese system.

So this really is a question about whether or not policymakers in China will step in. I don't necessarily see this becoming something that tips China into a recession right now, but it could prolong a significant economic slowdown. And China as the world's second largest economy, a significant consumer of industrial metals, of energy, that could have profound effects on various producers. Like we saw the steel producers there, we saw Deere down as well, Caterpillar down.

I do think that there are some concerns for various pockets of the US economy here. But the direct impact, the financial system contagion should be well contained. If not, something that causes just a little bit of a headache during this Fed week.

- And Christopher, just a follow up on what you said about this being insular to the Chinese economy and the real estate sector, does that mean that outside investors, foreign investors are unable to buy bonds or debt that may be tied to Evergrande and that's why there wouldn't be a contagion? Or is there something else at play?

CHRISTOPHER VECCHIO: Well, I do think right now, where things stand from the Chinese perspective, foreign investment has been dwindling in recent years. And particularly, with the pandemic, China have more or less started shutting its doors to outsiders. I do think that China is using this scenario, this way this thing are playing out right now, as a way to move forward towards their rebalancing of the economy.

So in part, China does want markets to sort themselves out, to take a little bit of cream off the top, if you will. But I don't think that China is going to allow this to become such an issue, where it imperils other initiatives that they have. Like what we had just seen in the previous interview, the Belt and Road Initiative, obviously, is very important for them.

Anything that could imperil their ability to become a world leader in their efforts to have a global reserve currency, I think, would become particularly problematic. And so we are starting to enter in the very fearful part of this. Fear has accumulated very rapidly here in the United States and other markets as well. And I don't think that China is going to let this spiral much further out of control before we begin to see some commentary come down the pipeline.

It wasn't lost on me, Adam, that this weekend, none of China's major newspapers released any commentary whatsoever on Evergreen. And I think that's because they themselves are waiting to see what comes down from the very top.

- Of course, going back to what you said before just in terms of what this could mean on a global scale, there are some concerns for specific areas of our economy. So with the Fed kicking off its two day meeting tomorrow, do you think there will be anything substantial? Or, I guess, how do you see this potentially affecting the meeting at all?

CHRISTOPHER VECCHIO: I don't know if it's going to affect the meeting in the sense that the Fed would delay their taper announcement as a result of what's been happening in financial markets. But I do think that if the Fed were to step back and say, China's issues are something that could threaten the US economy, that will actually add fuel to the fire.

So for the sake of having some confidence right now, they're going to look past it. They're going to continue to say that we're monitoring situations around the world. We're keeping an eye on the US debt ceiling debate. But as the US economy has progressed out of the summer weathering some of these Delta variant concerns, jobless claims have remained low, we've seen retail sales continue to push up to very strong levels, the Fed is going to slow play this.

So the way I see this, the Fed, if they do make any sort of recognition or acknowledgment of what's happening in China and the ensuing impact on US markets, it's going to be a wink and a nod. It would not be prominent. In making it prominent, it would elevate the fear. And that could actually deepen a sell off, which may imperil their taper, best laid taper plans. So far as it goes right now, do we see a taper announcement? Yes, but no official beginning until the end of the year.

- OK. And real quick, there's been a lot of chatter on other financial platforms about VIE's and how investors on our side of the Atlantic may not quite understand what they're purchasing when they're buying stock or Chinese equities. What do you think is the takeaway and a lesson that a lot of people may learn very quickly and painfully?

CHRISTOPHER VECCHIO: It's certainly a buyer beware situation. You know, a lot of the times when, you know, Americans are investing abroad, they are doing so based on some macroeconomic picture. This country is growing at such and such rate, and that offers better returns than what we're seeing here in the US. These type of episodes, however, they are difficult for the regular retail investor to get back on board with taking that kind of risk henceforth.

You know, there's an expression that comes to mind, trust is gained in drops and lost in buckets. If you're someone who had just recently invested abroad, this may not be something that entices you to return to the markets anytime in the near future. So for your average investor out there right now, if you've been in the market for just a few days, or a few weeks, or since the start of the summer, you're not obviously having a good time. But long term here, big picture, this is merely a bump along the road. This is perhaps necessary.

The S&P 500 up until today had not seen a 5% pullback all year long. Typically, since 1950, the S&P averages about three 5% pullbacks per year. And so we are taking a lot of froth out of the market right now. I do think this sets up a very interesting scenario, where over the next few weeks, perhaps, we see a little bit more weakness and uncertainty. But if we can bottom out by mid-October when the seasonals begin to turn, it sets up an interesting case for a bull market rally into the end of the year.

- Chris Vecchio, thanks so much for taking the time to join us today. Analyst with Daily FX.com.