Zhongzhi Enterprise Group to Crash Global Stocks?

With summer drawing to a close, the market is entering one of its worst seasonal periods of the year. That’s particularly troubling for bulls considering that stocks ripped endlessly higher through July.

The S&P made a moderate gain of 0.4% through noon today nonetheless, while the tech-heavy Nasdaq Composite did slightly better, recording a 0.7% jump. The Dow Jones Industrial Average, on the other hand, edged higher by nearly 0.1%, equivalent to around 23 points as financials sagged.

Tesla shareholders might not be in the best of moods, either, as shares plunged by 2.3%. This drop is attributed to Tesla’s decision to slash prices for some Model Y units in China. It’s a stark reminder that the stock market rally of 2023 is waning as the S&P 500 and Nasdaq dipped last week by 0.3% and 1.9%, respectively. This marked a rare two-week downturn for the Nasdaq Composite in this calendar year.

But a silver lining was to be found for the Dow, which registered a 0.62% uptick last week, making it the fourth positive week in the last five.

The broader market will be keenly eyeing reports this week, with significant focus on U.S. consumer data. Retail giants like Home Depot, Target, and Walmart are set to unveil their earnings, while July’s retail sales data comes out Tuesday morning. After a mixed bag of inflation reports last week, the market remains wary. The current inflation trend, although lower than the post-pandemic peak, remains unsettling, hovering well above the Federal Reserve’s 2% benchmark.

The market’s current trajectory is less than ideal. Still, some analysts remain optimistic, suggesting that the broad market’s pullback since the end of July might just be a recalibration, not a swan song for the bull market.

Over in China, though, sentiment is already swinging sharply lower as a looming financial “time bomb” casts a long shadow.

Analysts are raising red flags over what some are calling a “debt crisis,” potentially dwarfing last year’s Evergrande debacle, in which China’s (formerly) largest property developer accrued over $340 billion in debt (roughly 2% of China’s GDP) that it couldn’t pay. More recently, now largest Chinese developer Country Garden triggered alarm bells by entering a grace period for two of its bonds. It painted a grim picture reminiscent of the Evergrande scenario.

But it gets worse: Zhongzhi Enterprise Group, a “secretive financial conglomerate that manages about 1 trillion yuan ($138 billion)” according to Bloomberg, has missed several payments, fueling concerns about a cascading financial crisis. This has particularly affected the shadow banking sector, a massive asset class that’s central to the Chinese financial landscape.

Zhongzhi, although not a household name outside China, is instrumental within the country’s $2.9 trillion trust industry. The company’s financial struggles come at a critical juncture, with the world already eyeing China’s economy and property market apprehensively with Country Garden/Evergrande.

Info from data provider Use Trust reveals a telling tale. As of July 31, 106 trust products, valued at 44 billion yuan ($6 billion), defaulted. Real estate ventures were the primary culprits, accounting for a whopping 74% by value.

The linchpin for Zhongzhi’s financial woes? It appears that the company placed heavy bets on real estate last year, anticipating a market resurgence that, unfortunately, hasn’t materialized. Shen Meng of Beijing-based Chanson & Co. expressed that the crux of the challenge lies in preventing the ongoing Zhongzhi saga from undermining trust in the broader industry.

“The biggest problem now is how to isolate the risks associated with Zhongzhi group so that it doesn’t cause confidence of the entire trust industry to collapse,” Meng said.

“If the situation continues to worsen, expect the scale of the risks to be no less than when a leading property developer defaults.”

Zhongzhi’s intricate web of investments isn’t limited to real estate. The company has a diversified portfolio that encompasses mutual funds, asset management companies, insurers, and even coal reserves.

However, the tremors from China’s financial landscape aren’t going unnoticed. Following the revelations surrounding Country Garden and Zhongzhi, Chinese stocks faced headwinds, with the CSI 300 Index taking hits in five of the last six sessions.

Yet, global markets seem hesitant, almost waiting for the other shoe to drop in China. ING’s Carsten Brzeski captured the sentiment aptly, highlighting the distinctly different trajectories between the recovering U.S., a struggling Europe, and a lagging China.

“For the very first time in a long while we are seeing this global divergence,” Brzeski noted.

In the face of these global financial intricacies, Truist Advisory Services’ Keith Lerner reflected on past narratives surrounding China, now proven awry. Whether it’s the hope-driven rallies around stimulus or the conviction about Beijing’s interventions, the reality seems to be asserting itself more prominently.

“You talk about the stimulus, and you had this big rally on hope,” Lerner said. “You’ve given all of that back.”

For Lerner and his team at Truist, their bearish outlook on China seems to have been the right call.

“From an asset allocation perspective we’ve been very negative on China, and that’s one of the reasons why we’ve been basically zero allocation on our global portfolios to EM since last year,” he explained.

Overall, while Wall Street may have its intermittent challenges, the rumblings from China suggest that investors globally need to tread with caution. As China grapples with its financial challenges, its influence on global economic trends is undeniable. Only time will tell how these dynamics unfold, but with US stocks teetering on the edge of a deeper correction, China might be what ultimately tips stocks into a broader market selloff.


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