How to Trade the Volatility Around Evergrande

Earlier this month, a black swan landed on Tiananmen Square and stirred speculation about what this would symbolically mean.

China already had a rough year: dealing with floods, typhoons, hailstorms, sandstorms, landslides, and a pandemic.

Black Swan on Tiananmen Square
Black Swan on Tiananmen Square

Unlike Americans who diversify into stocks, bonds, and real estate, Chinese people largely invest in real estate. Young couples spend all their savings plus a great portion of money given by their parents as a down payment for an apartment. You even need a house, a job, and a car if you’re going to marry a Chinese girl! It’s a pseudo-capitalist culture gone completely out of whack.

This has led to a rapid unsustainable rise in housing prices in some parts of China. Buildings are frequently built by developers who want to turn a quick profit, and neglect quality. You get tofu-dreg construction as a result.

Collapsed building due to tofu-dreg construction
Collapsed building due to tofu-dreg construction

They are bought by people who hope to sell them at a higher price to the next sucker anyway. This process can perpetuate itself until a catalyst presents itself.

Enter Evergrande

All it needs to pop this housing bubble is a catalyst. Enter Evergrande: China’s second-largest real estate developer. On September 8th, Evergrande Wealth failed to deliver interest payments to its clients. Victims and clients staged large-scale protests at Evergrande’s headquarters for several days in a row.

Protests at Evergrande’s headquarters
Protests at Evergrande’s headquarters

On August 31, Evergrande confessed that work on 1.5 million properties have been halted due to delays in payment to its creditors, suppliers, and contractors. It was due on another loan payment today, but told banks it was unable to pay it.

If China’s real estate bubble bursts, it can take out its financials and real estate companies. This contagion spreads to world financial sectors that are overexposed in Chinese real estate junk bonds.

As soon as financial institutions around the world need additional liquidity to cover their defaulting bonds, they’re going to sell overhyped tech companies first. The same ones that we’ve propped up with revenue multiples beyond 50 after COVID-19 hit. The Nasdaq index is going to suffer hard. Is this a 2008 “Lehman moment”?

How to Manage the Volatility

My Nasdaq trading system issued a short signal last Friday. Accordingly, my students are already in a short position and I recommended that they put on a hedge for their portfolios.

If you follow trends, the market will give you early signs of trouble before a major move occurs. We didn’t even know exactly what the news was when we shorted, but it didn’t matter because price action is the only thing we had to watch.

Once the fog clears around Evergrande, I will tell you when to remove the hedge.

If you want to learn about my trend following strategies and mindset, start with 3 simple trading strategies. Provide your email and I’ll send them over.

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About Matthias Hagemann

Matt Hagemann

I share my 15+ years of trend following experience. Aspiring traders come to me because they want to make consistent profits without stress and without day-trading.