This Market SellOff Is Overdone — Here’s Why

U.S. markets plunged Monday amid growing concerns about the debt ceiling, a pullback from the Federal Reserve, and potential contagion in China.

But here’s the reality; as usual, investors are overreacting.

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Granted, I’ve long argued that the markets might be positioned for a bit of a pull-back. And, a small retreat might even be healthy. After all, the Federal Reserve’s ultra accommodative policies, combined with multiple rounds of stimulus from the federal government, have left investors flush with cash. As such, the normal yin-yang of the market…or, buy-sell equation….has been thrown out the window in pursuit of more and more yield.

And, let’s be clear, there’s no yield in a 1.3% 10-Year U.S. Treasury bond.

So, naturally, investors have sought risker and risker assets, primarily in the equities markets.

Now, that may be slowing down…but, not for long. The Fed is still waiting in the wings.

Financial Voodoo From the Fed

Indeed, investors would be wise to remember is that the Federal Reserve (which will provide markets with an update on their policy this Wednesday) is trying to help and whether you agree with that or not (I, personally, think the Fed has way overstepped its role and should be focused more on inflation than employment) the Fed remains committed to creating a kind of easy-street for investors.

As such, while they may communicate an effort to pull back their bond purchases on Wednesday, investors should be aware that they’ll stay flexible and its highly unlikely they’ll pull the rug out from under …especially if the country is still dealing with the spread of Delta as we head into winter months.

China’s Lehman Moment

The other worry is China. Evergrande is a large commercial property developer in China that may go bust. The Chinese government (surprisingly) has shown little desire to save it and, as such, there are those that believe this could be a “Lehman-like” moment for the communist ruled country. Evergrande could certainly go under…and with $300 billion worth of liabilities, its failure could have a massive effect on other businesses in the region.

As for those challenges spreading to other countries including the U.S. in a massive, system-style way? It’s unlikely.

For starters, U.S. (and European) banks have undergone multiple stress tests in recent years to ensure they are prepared for such challenges. Meanwhile, Evergrande’s debt hasn’t been sold, (and resold, and resold yet again) in elaborate derivative products designed to camouflage risk.

Assuming U.S. banks aren’t long Evergrande debt (and it does not seem they are) a stumble in China should remain just that. Companies go out of business all the time, while this would be a big one, its effects should be primarily confined to Chinese banks, Chinese insurance companies and other real estate companies.

Of course, it’s not good when one of our trade partners is struggling, but investors need to question whether Evergrande Group’s potential demise would cause a massive issue here at home? And, the answer is: it’s unlikely.

Widespread Economic ‘Catastrophe’

The last worry the markets are growing concerned about is the so-called debt ceiling. Treasury secretary Janet Yellen is urging Congress to act quickly or risk ‘widespread economic catastrophe.’

The term ‘economic catastrophe’ is a pretty big one. But that’s exactly the warning Yellen issues in an op-ed published by the Wall Street Journal on Monday.

While urging congress to increase the debt ceiling (something it has done about 80 times since 1960) she wrote that the U.S. was currently at risk for not paying its bills. By not raising the ceiling, we would default on our debt and, “Doing so would likely precipitate a historic financial crisis that would compound the damage of the continue public health emergency. …We could emerge,” she writes, “from their crisis a permanently weaker nations.”

She’s right.

Of course, we shouldn’t be in this position to begin with…and, if anyone in Washington actually could “do” math, we wouldn’t be.

But alas, if you haven’t figured it out by now, we do not have the best and the brightest in our Congress. And, we keep spending money we do not have. And we keep “kicking the can down the road,” raising the debt ceiling, printing more money, and digging ourselves into an even bigger hole.

Ultimately, I’d expect that Congress will raise the debt ceiling again, but there will be a lot of hand-wringing in the process. Republicans and democrats alike will use this as a political weapon.

There are certainly long term issues plaguing our system: from too much reliance on financial engineering from the Federal Reserve (and the risks that creates) to politicians refusal to act responsibly with our money. But, the immediate issues (from the Fed, to China to the debt ceiling) are all quite fixable.

The U.S. markets should be in the clear…and ready to move higher for now. Smart investors might be looking at down days like Monday’s sell off as an opportunity.

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