There are several perceived headwinds in weaker global growth, inflation concerns, rising input costs, peak profit margins, the Fed's policy shift and recently concerns about China's credit markets.

But let's take it one step at a time.

How concerned should investors be about Evergrande's problem?

To begin with, it is good to do a little history:

• The real estate sector has always been highly regulated given the large role it plays in the economy and has undergone multiple cycles driven by periodic regulatory adjustments. However, regulations have evolved in the last 2 years from land auctions to balance sheet management to reduce macroeconomic risks. This is very much in line with a broader objective that China is prioritizing economic and social stability.
• We believe that the current problems facing the sector are more company-specific, exacerbated by regulatory tightening. The government is clearly trying to force state-owned enterprises to be more careful in risk management, so defaults may be allowed. That said, we believe these would be relatively "orderly" without triggering systemic risk. To contain side effects to the system, the central government is likely to ask local governments to inject capital or ask other developers to perform a "national service" by taking assets from developers facing liquidity problems.
• Several developers have faced liquidity problems in this cycle. However, even the largest companies at risk have total interest-bearing debt that is less than 0.5% of total corporate debt in the system and most of the debt (especially bank loans) is secured by real estate assets. Currently, the government is prioritizing the smooth delivery of apartments that are already sold to ensure that there are no complaints from the public and that confidence in the sector is not affected.

Now, while China could carefully manage any potential default or restructuring of Evergrande to protect the financial and real estate markets, it may need to do more. Economic data is already weak and a clear message from the government is needed to shore up confidence and stop the domino effect. The absence of such action poses a significant downside risk to growth going forward.

• In this regard, there is a widespread market expectation that the Chinese government will announce support measures for the overall economy before the October 1 national holiday, which commemorates the formal proclamation of the establishment of the People's Republic of China.. This is seen as a major problem for Xi Jinping and therefore the government is unlikely to tolerate any risk of chaos or shock to the economy ahead of this celebration. Current policies on property financing are very strict, on developer loans, land acquisition loans, trust/private equity funds and mortgage loans. It is not only difficult to obtain funds for new projects, but also to recover cash from completed projects. There should be some easing in mortgage lending before the end of the year, otherwise the real estate sector could face more systemic risks.
• Finally, the People's Bank of China has continued to inject short-term liquidity into the banking system through seven-day and 14-day reverse repurchase agreements to manage concerns about the state of its real estate and credit markets. through seven-day and 14-day reverse repurchase agreements to address concerns about the state of its real estate and credit markets.

In summary, we do not believe the sector faces systemic risks; over-leveraged developers will gradually sell their assets with central and local government support when necessary.

In another relevant milestone, the Fed strongly hinted that they will begin tapering asset purchases after the next FOMC meeting in early November. The statement following this week's meeting indicated that if economic progress "continues broadly as expected," then a slowdown in the pace of purchases "may soon be warranted."

The tapering signal was widely expected, given the strong indications from previous statements. While there is some conditionality attached to the November tapering decision, Powell made it clear that it would take a major disappointment to throw them off course.

But Powell went a step further by noting that "a gradual tapering process concluding by the middle of next year is likely to be appropriate." This assumes a per-meeting reduction in the monthly purchase pace of US$10 bn for Treasuries and US$5 bn for MBS.

Regardless of how the story finally ends and barring any major inflationary surprises, things continue to point to a very gradual normalization that would keep financial conditions fairly accommodative and despite concerns about the recent downward shift in economic data, we remain confident that strong growth is ahead and activity is set to accelerate again. We believe the recent slowdown is temporary and driven primarily by the delta wave.

We do not expect a permanent destruction of demand from this wave of Covid, but rather a delay in reopening and economic normalization. In fact, a growing number of indicators point to an inflection in the Delta variant. While Covid continues to decline, the strong momentum should continue into 2022 as companies begin to rebuild depleted inventories and increase capital spending. Central bank policies should remain growth-oriented, and even China's slowdown will likely be countered soon with a policy turnaround.

Against this backdrop, risk assets would continue to do well and bond yields appear to be finding a floor, which generally bodes well for cyclical value leadership.

A final thought. We see a lot of emphasis on high equity valuations, but less talk about the unattractiveness of corporate prime rates and spreads with little room to compress.

In this regard, we believe the correct approach is to continue to overweight equities over fixed income, where relative valuations continue to offer a large premium to their history, while for fixed income we recommend a conservative approach in terms of duration.

Investors should note that the Fed is moving forward because it has more confidence in the economy and will continue to provide support. While higher bond yields reduce the relative attractiveness of stocks, a gradual rise in bond yields should be more than offset by the positive impact of rising corporate earnings as economies return to normalcy. Therefore, the Fed tapering should be viewed as the gradual withdrawal of an emergency support measure as conditions normalize.