Good morning,

I hope you are enjoying the warmer weather and looks like we have this to enjoy going into the weekend. So far it has been a busy week and I have provided some color on the election and Monday’s market volatility.

Canadian Election

After 36 days, $600 million and much frustration, the federal election produced little change as the Liberals held on to their minority government. The Liberals with continue to rely on support from the leftist NDP who added a few seats, the Conservatives, while winning the most votes nationally, lost key seats in Ontario, the Bloc Québécois ended about where it started, and the Green Party had their worst turnout in 20 years. While these results are not final due to mail-in ballots, the overall outcome is not expected to change.

John Stackhouse, Office of the CEO commented this morning on the signals sent from the elections results. “First, Canadians largely don’t want radical change, no the left or right. From childcare to economic and climate policy, most Canadians seem comfortable with a moderately progressive agenda. After the Liberals started the campaign badly—at one point, insiders feared they could lose a dozen seats—they shifted left, as they did in 2019. Trudeau barnstormed urban ridings over the weekend, repeating the word “progressive.” Social issues also matter, perhaps more than economic ones. The Liberals convinced urban voters, especially in Toronto, that the Conservative were soft on guns, including automatic weapons. Moving forward, Trudeau may struggle to get significant bills through Parliament—a frustration that pushed him to call the election—and will need a more negotiated approach to government. But that may be what Canadians want. Five of the last seven federal elections led to minority governments. Politicians now have to make one work through a prolonged pandemic and uncertain recovery.”

 

Market Volatility

Although it certainly isn’t a new story, the growing problem towards default at the Chinese property developer, Evergrande Group, filtered through into markets yesterday. Monday was a proper risk-off day, with equities falling globally, credit spreads widening, and the 10-year treasury yield falling over 6 bps. While we witnessed some recovery Tuesday, and this morning at the time of writing, the constant comparisons to the fall of Lehman Brothers in the financial media are likely contributing to some nerves, but today those outlets all seem to be explaining why Evergrande is not going to be a “Lehman moment.”

Below, RBC Portfolio Advisory Group has summarized a few of the salient points and illustrate how global credit markets have shown little concern for the developing story with Evergrande.

• While Evergrande’s overall liability figure may be Lehman-esque, most of those liabilities are not in the form of debt, and of that debt, about 80% is in the form of on-shore Yuan denominated obligations
• China has a great deal of direct input into their domestic economy, and a disorderly liquidation is not in their interest – the previous examples of Baoshang Bank and Huarong Asset Management showed how the Chinese Communist Party (CCP) and People’s Bank of China (PBOC) are willing to intervene directly (if not necessarily bail out) to limit contagion
• Levels of liquidity in the global economy today are almost unrecognizable compared to where they were 14 years ago, and the implicit backstop from monetary policymakers makes a 2008 style credit crunch significantly less likely
• The primary mechanism where Evergrande could leak through to global markets is via slower growth in China if this marks the beginning of a more hawkish than expected deleveraging policy course from the CCP
• Bad loans in proportion to the overall Chinese real estate market are much lower today than they were at the time of the GFC

RBC continues to see this as a story worth monitoring, and a great deal about how this unfolds depends on the reactions of the CCP and PBOC. But we also think investors can take a step back from the more cataclysmic prognostications, and see Evergrande’s situation as one risk among many to global growth prospects, but a much smaller risk overall to the health of extremely well supported corporate credit in developed markets.

Please let my team and I know if you have any questions, or if there is anything we can do to assist.

Best,

Devin