The corrective action that has been brewing for a couple of weeks is accelerating this morning on headlines that Chinese property development firm Evergrande is about to default on roughly $300 billion in debt. This is creating fear of a possible contagion that will spill over into other areas of the market around the world. China has already been cracking down on speculation, and there is concern that it may not rush to support Evergrande, but this is one of the largest real estate development firms in the world, and there is much discussion that it is 'too big to fail.' China may have little choice but to help bolster economic sentiment.
As is so often the case, the negative news coincides with a market that has been struggling and looking for a good reason to correct further. It is often market conditions that determine the degree to which a news event matters, and this is a good example of how poor negative news and poor technical action tend to coincide.
The primary issue for market participants is how deep will this corrective action run. There is some fear this morning, and that will help to move the market more quickly to some support levels, but it will likely take a little time for the market to fully discount these events.
Although this looks very dangerous right now, the big opportunity in this market lies in the fact that a large number of stocks have already corrected very deeply and are struggling to build support. Even though the action has been poor for a couple of weeks, there has been underlying support in the form of speculative trading in many secondary stocks.
The positive spin on this action is that the indices and big-caps are simply catching up to the downside with a great number of other stocks. It had to happen at some point. What we need to watch for now are areas of relative strength. I suspect that we will see small-caps and speculative stocks outperform again as they did on Friday. That doesn't mean they are going to go up, but they are not likely to be as bad as the indices and big-caps.
Keep in mind that the Fed will issue its latest interest rate and policy decision on Wednesday at 2 pm ET. There is no way that Jerome Powell and his crew are going to allow the Evergrande issues to spill over and impact the economic recovery in the U.S. The Fed will do whatever is necessary, and if that means a delay in tapering off bond-buying, then so be it.
While the Evergrande situation is a perfect excuse for speculation about a contagion, I suspect that it will just hasten the much needed corrective action in the indices and will help secondary stocks to produce relative strength.
