Evergrande, contagion, and the uncertainty risk of not knowing

During extreme market bull moves, investors think they know too much or don't need to know the details. Everyone has a story for why something should go up. In fact, there is a "don't confuse me with the facts" mentality. I have the story follow the momentum. 

In a bear market, fear of the unknown takes over. We know too little and act accordingly through avoidance. There is a desire for more facts because no detail is too small.  

The Evergrande debt situation is constantly changing not with solutions but with revealing more information on how bad is the situation and where risks are growing.

Some have discussed Evergrande as a Chinese Lehman moment only to dismiss this extreme story. Lehman comparisons are irrelevant. What is critical for most investors is the issue of contagion. An investor may not hold Evergrande but the spillover to other companies will impact my portfolio. There is more than one type of contagion and investors should be aware of the differences. 

One form can be called tangible contagion. A failure of a firm can have an impact in their suppliers, buyers of their services, and banks that lend to the firm. These are direct spillovers. 

A second form of contagion can be associative. There are firms within the same industry which will be affected with negative perception. In this case, other property firms. However, this contagion can have a short life as investors compare and contrast risks. 

The third form of contagion comes from the unknown or intangible risk. There are direct Evergrande risks, but I don't know how this will spill-over to other firms, what will be the rule of law in China, the regulatory environment in China, how dollar debtholders will be treated, the risks for other highly levered firms, or the risks to construction in China. 

All of these are current unknowns that cannot be easily handicapped. This is uncertainty that cannot be measured. Hence, there will be a general exit from any risks that can be tied to the Evergrande environment or ecosystem. This general pullback may not make sense, but it is tangible and will affect global markets. we are seeing this contagion and the process is not over. Some will just call this a risk-off environment. The name does not matter. What matters is that high uncertainty will lead to large rebalancing flows away from risky assets.