Wall Street saw its worst trading day in months on Monday, following the global realization that a Chinese real estate giant is on the brink of collapse.
Now investors, analysts, and broader finance community are working to figure out what’s next.
The U.S. equity market has posted a stunning rise since COVID-19 first took hold in early 2020 and sent stocks spiraling. Even in the face of a worsening pandemic, a divisive election, and an insurrection, the S&P 500 still managed to hit record high after record high, with an influx of liquidity from the Federal Reserve helping it along the way.
And then, on Monday, stocks plunged in stunning fashion—setting off a wave of questions about whether this is the beginning of a correction.
Overnight, investors in Asia reckoned with a double-digit decline in the Hong Kong-listed shares of China Evergrande Group, a heavily indebted property developer that is expected to default on $300 billion of debt this week. The drop was quickly felt in financial markets around the world, including in the U.S., where investors sent the S&P 500 down by as much as 2.8% intraday. Ultimately, the index recovered some of its losses to end the day down 1.7%—still marking its worst performance since May. Small-cap stocks were hit even harder, with the Russell 2000 dropping 3.6% at its intraday low. It closed trading down 2.4%.
Few on Wall Street seem to think Evergrande’s expected default was the sole catalyst for the sell-off, though. Instead, the prevailing sense is that Monday’s decline was a long-awaited conclusion: not all stocks can go up all the time.
“It’s almost as if the market was looking for a reason,” Liz Young, head of investment strategy at SoFi, told Fortune. “Today, it got it.”
Since the COVID-19-induced bear market of 2020, stocks, cryptocurrencies, and other asset classes have been on a seemingly never-ending rise. However, the U.S. stock market is operating today under a series of economic and geopolitical risks—the Delta variant’s continued spread, the Fed’s eventual tapering announcement, and broader economic and regulatory issues in China that reach beyond Evergrande—that have created a looming sense that a pullback is near.
In one of the starkest warnings yet, a team led by Morgan Stanley Chief Investment Officer Mike Wilson concluded Monday that the S&P 500 venturing into bear market territory, with a 20% or more decline is becoming more likely. Even the less dramatic alternative, in Morgan Stanley’s eyes, is still a “healthy 10% correction.”
The Evergrande situation does raise concerns on a global magnitude, considering the importance of the real estate market to China’s economy. Bo Zhuang, a China economist at Loomis Sales, estimates that at least 70% of Chinese household wealth is invested in the country’s property market, as Fortune‘s Grady McGregor reported. But it is still unclear if Evergrande will be bailed out by the Chinese government or not, which has created a guessing game around whether the company will end up as the latest Bear Stearns or Lehman Brothers.
Either way, it is yet another weight investors now find themselves grappling with in the middle of what has historically been the worst month for the S&P 500 and the Russell 2000. “It’s just one more brick in this wall of worry,” CFRA Research Chief Investment Strategist Sam Stovall said of Evergrande in an interview with Fortune.
But Michael Antonelli, a market strategist at Baird, says there have been few signs that Monday’s sell-off is the start of something bigger in the all-knowing credit markets. Rather, Antonelli views what’s to come in the aftermath of the Evergrande situation in the U.S. similarly to what followed the implosion of Long-Term Capital Management in 1998: The market reaching an all-time high.
“I think we continue to grind higher,” Antonelli told Fortune. “We’ve seen these financial stresses before.”
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