Will China’s Real Estate Woes Cause Bearishness in the U.S.?

China’s Evergrande crisis exposed cracks in the country’s real estate sector, and this could have a domino effect on other countries around the globe, including the U.S. — or could it?

The U.S. is all too familiar with a real estate crisis, as overinflated housing values coupled with risky, poorly-underwritten mortgages helped cause the financial crisis in 2008. China could be experiencing their own version of that following large property developer Evergrande’s default on its bond payments.

“Stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States,” the Federal Reserve said in a financial stability report.

It’s definitely something the country doesn’t need following the wake of the start of the pandemic in 2020. While the country has been on track towards a recovery, its real estate woes certainly won’t accelerate growth, especially since housing activity accounts for 29% of its GDP.

“The nexus of the Fed’s concern is that China’s real estate activity is slowing, but the developers have large debts [and] some of them (like Evergrande) are diversified into other areas of the economy,” said Paul Christopher, U.S.-based head of global market strategy at Wells Fargo Investment Institute.

If the effects do spill over into the U.S. and cause real estate to falter, traders can pounce on an opportunity with the Direxion Daily MSCI Real Est Bear 3X ETF (DRV). DRV seeks daily investment results equal to 300% of the inverse of the daily performance of the MSCI US REIT Index, which is a free float-adjusted market capitalization-weighted index that is comprised of equity REITs that are included in the MSCI US Investable Market 2500 Index.

DRV invests in swap agreements, futures contracts, short positions, or other financial instruments that, in combination, provide inverse or short leveraged exposure to the index. Traders who want to take the other side of the trade can opt for the Direxion Daily MSCI Real Estate Bull 3X ETF (DRN).

An Isolated Issue

Despite the Fed’s warning, some market analysts maintain that China’s real estate troubles are an isolated issue. Low inventory and strong demand for real estate in the U.S. should help buoy the sector, while mortgage interest rates still remain low by historical standards.

“I think the risks to the US are small since the closed nature of China’s financial system means contagion is not likely to be a big problem,” said Arthur Kroeber, who helped found China-focused research firm Gavekal Dragonomics in 2002.

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