Why China's COVID Crackdown Matters to U.S. Stocks

'Zero COVID' still isn't working in China... China's exports slowed last month... Traffic jams at sea... Why China's COVID crackdown matters to U.S. stocks... How to survive a 'nuclear winter'... More of your feedback on the Fed...

What I'm about to say could get me jailed in China...

But I (Corey McLaughlin) won't be going there anytime soon, so here it is...

"Zero COVID" is not working... for a lot of people, at least. If fact, it's making things worse.

If you've missed this part of the pandemic story over the past several months, the details are quite shocking... and, even with all the pandemic-related messes here in the U.S., it has me feeling fortunate for where I'm reporting from today...

Back in January, I wrote that the Omicron variant was just getting started in China... and noted that this fact could contribute to a global economic slowdown... and more inflation. It was a recipe for potential stagflation... even before war broke out in Eastern Europe.

It's now four months later... and not much has changed... The Chinese government insists on adhering to its no-tolerance policies that aim to stamp out every case of the virus from the country... to keep its economy strong long term and not overwhelm hospitals...

Maybe it's a lose-lose situation no matter what anyone does, but unfortunately, China's policy worsens the very things – the economy and people's health – that the government says it wants to protect... Let me explain.

In China today, it's like it was in the U.S. at the start of the pandemic in March and April of 2020… There are more questions than answers.

We'll avoid the politics of this, and talk about the economic impact...

Given how easily the Omicron variant spreads compared with previous iterations... and what we now know about the virus in general, erasing COVID-19 from any part of Earth is always going to be a difficult goal to accomplish...

Heck, while nobody seems to be paying attention anymore, COVID-19 cases have been trending up in the U.S. over the past month... Roughly 110,000 new cases were reported yesterday. We're in the "living with COVID" era now, though no one has told us as much...

But the Chinese communist government wants to live without it... and so it goes...

Over the last several months, many of China's – and the world's – biggest cities have been locked down, as a result of mostly asymptomatic COVID-19 cases in the population...

Chinese citizens have been enduring strict quarantines and testing policies for months... The latest is that test sites are being set up within a 15-minute walk apart in major cities, as negative test results are required to go to school, work, shop, or eat out...

We could get into more chilling 1984-like details – including panic in the streets... watch this censored-in-China YouTube video for examples – but we want to get directly to our point about why this matters to the economy and markets.

It's simple... yet powerful. China is the world's second-largest economy... and a producer of goods that a lot of the rest of the world buy... So when people can't leave their houses... a lot of important business is disrupted. Things don't get made.

We all lived this in the U.S. two years ago... Workers can't work. And goods don't move... Or if they do, they don't move as fast as they did previously... So given what's happening in China today, that means more of the same problems we've seen over the past two years as well.

Chinese exports slowed dramatically last month...

In data published yesterday, China's export growth slowed for April to single digits, 3.9%, a dramatically sharp drop from the 14.7% growth reported in March. It was the lowest number since June 2020.

The biggest drops were in shipments to the U.S. and Europe, and particularly in electronics...

In China right now, for example, factories that make microchips have been shut down... and many companies, like tech giant Apple (AAPL), for example, warned recently that China's COVID-19 lockdowns could shrink their bottom lines in the second quarter of 2022...

Apple supplier Foxconn, which makes iPhones and iPads, among other notable items, was among Chinese companies to suspend operations recently. As Stansberry NewsWire analyst Daniel Smoot reported last week after Apple's first-quarter earnings call...

[Apple] CFO Luca Maestri noted that COVID-19 lockdowns in China may put pressure on AAPL's suppliers and sales, which could fall by $4 billion to $8 billion in the current quarter.

That's a lot of money, and the uncertainties are further amplified by the war in Ukraine. It turns out, neon gas is a critical ingredient for the production of semiconductors... and reportedly half of the global supply comes from Ukraine...

But even if the supply of semis was "normal," at this point, chances are you'd still have a delay shipping them out of China. Because of the lockdowns, backups at Chinese ports like the one at Shanghai – the world's largest container port – are long...

Stuck at sea...

Last week, analysts at Royal Bank of Canada (RY) published research showing that one-fifth of the global container-ship fleet was currently stuck in congestion near or at various major ports around the world.

In case you haven't learned yet why this matters, here's what our colleague Kim Iskyan wrote about cargo ships and containers in the September 22, 2021 Digest...

Around 90% of total world trade in goods is transported by sea – which amounts to around $14 trillion in 2021, equivalent to about two-thirds of U.S. gross domestic product ("GDP") last year... And of that, 60% is carried in shipping containers.

Those rectangular steel boxes, generally either 20 or 40 feet long, are the foot soldiers of global trade. They carry everything from Hanes T-shirts to computer motherboards – and my household goods – to and from ports all around the world.

A 40-foot container holds 2,390 cubic feet of stuff – large enough to fit the contents of a standard four-bedroom American home. It can store around 160 barrels of oil or more than 12,000 shoeboxes. And four medium-sized cars can fit, end to end, in a 40-foot container.

Cargo on the sea still isn't flowing at pre-pandemic levels along the U.S. West Coast, for instance, but have gotten better since last year. This is not the case in China...

As of last week, in China, ships awaiting a spot at the Port of Shanghai totaled 344, a 34% increase in a month... Meanwhile, shipping something from a warehouse in China to one in the U.S. takes about 74 days longer than usual.

Here's what the traffic jam looks like in the China Sea today...

And here's the waiting game being played in the waters off Shanghai. You can see the collection of cargo ships (the green dots) and tankers (red dots) anchored in formation, waiting to reach the port...

There's simply not enough dock workers or crane operators and truck drivers in China's ports right now, says supply-chain management expert and Australian National University professor David Leaney. As he told news.com.au today...

That's causing a disruption to the whole system which is all interconnected...

There's enough shipping containers to circle the equator four times, but at the moment, instead of being smoothly spread out around the world, they're logjammed in these traffic jams in Shanghai and other places.

Leaney said the lead time to get wood to frame a house is 46 weeks... new car production is behind by 12 to 18 months... and the price of a shipping container has increased anywhere from three to five times.

It all adds up to higher prices for buyers...

Back to chips, for instance. Taiwan Semiconductor Manufacturing (TSM), the world's biggest contract chipmaker, said today it will raise prices early next year, reportedly by 5% to 8%... on products like advanced processors and connectivity chips.

It's the second time in less than a year that the company has announced price hikes. And as Daniel wrote in the NewsWire today...

The change may ultimately further weigh on major electronics companies and the automotive industry – as many businesses are still operating with an undersupply of semiconductors. And increased prices could add to existing cost-related woes, resulting in weaker output for various products.

On the flip side, we could see other semiconductor companies make similar announcements in the weeks and months ahead. With the global chip shortage expected to run through 2024 – if not longer – demand will remain elevated for quite some time. And as this trend continues, prices could further rise to account for necessary production expansions – likely helping chipmakers to offset capacity constraints with higher margins.

Importantly, as we've pointed out in the past, it's not like supply-chain issues get worked out as soon as workers come back on the job anyway...

Bottlenecks take more time to loosen than most people realize... and that means that in the months ahead, at the very least, we'll be seeing more of the same problems we've seen the last two years...

Shipping delays... Supply shortages... and inflation...

Maybe this isn't news to you anymore...

We did write about China's "zero COVID" story just last month. But I revisit it today because the state of the economy in China matters a lot to what happens to businesses and stocks all over the world...

If supply delays have a material impact on businesses and prices, which is likely, it means more fuel for the biggest factor creating volatility in the markets today, especially in the U.S...

Inflation...

Numbers are still rising... Neither the Federal Reserve nor Wall Street institutional investors are really sure how the inflation story will play out the rest of the year, but so far, it doesn't look good...

Even if the inflation rate decreases, inflation will still be higher than we've lived with in recent memory. We'll get another look at "official" data tomorrow morning, when last month's consumer price index ("CPI") report is published.

If high numbers continue – which we expect – the central bank says it will continue to raise its benchmark lending rate, for example, which can slow demand for things... and reduce economic growth... through the rest of 2022.

That means possibly more of the volatility we've seen already this year...

Slower growth and high inflation combine to mean lower earnings for businesses... or lower Wall Street analyst expectations for earnings... which typically means selling... and lower stock prices across the board as a result.

Slower growth could also mean businesses cut costs, like wages... and unemployment rises. This outcome seems to be expected by the Fed, or at least one policymaker at the central bank, as NewsWire editor C. Scott Garliss reported today.

New York Fed President John Williams said as much during a conference in Germany today and he mentioned China specifically. As Scott wrote...

Williams noted that inflated demand created by the coronavirus pandemic kicked off the cycle of rising prices. He elaborated that China's zero-COVID policy and Russia's invasion of Ukraine, are worsening the near-term outlook for prices.

Worse, we could see higher interest rates, possibly a recession – in fact, we're halfway to the conventional definition already, with a 1.4% decline in U.S. GDP in the first quarter of 2022 – and inflation that still doesn't go down enough.

What then? It wouldn't surprise me if central banks first go back to the "easy money" train and throw more stimulus at the problem – the argument being inflation is as low as it's going to get and "We need to get the economy back on track."

In other words, the cycle of artificially managed economies goes on... and the consequences do too...

Given what's going on in China and the rest of the world today, it's wise to prepare for higher-than-usual inflation to stick around one way or another... and longer than most people probably think.

How to Survive a 'Nuclear Winter'

In today's rough market, value stocks remain a beacon of hope for investors... and there's no one better suited to discuss this idea than recurring Stansberry Investor Hour favorite, Tobias Carlisle.

Carlisle is the founder and managing director of deep-value investment firm Acquirers Funds, centered around his trademarked valuation tool – the Acquirer's Multiple – which is favored by institutional investors and buyout firms.

In this conversation with our Dan Ferris, Carlisle shares insight into his proprietary work... breaks down the art of valuation... how he decides to buy or sell... and offers his thoughts on today's market and how to endure the tough times.

He says stocks "that can survive a nuclear winter" are the keys to surviving this bear market. These are deeply undervalued companies – ones that are buying back shares, are cheap, and are growing at a reasonable pace...

Click here to listen to this episode right now. And to catch all of the videos and podcasts from the Stansberry Research team, be sure to visit our Stansberry Investor platform anytime.

New 52-week highs (as of 5/9/22): Campbell Soup (CPB), General Mills (GIS), and Zanite Acquisition (ZNTE).

In today's mailbag, more of your feedback on the Federal Reserve stemming from last Thursday's Digest... Keep your notes coming to feedback@stansberryresearch.com.

"In response to [Thursday's] question, I think the reasons the Fed didn't act sooner to raise rates was primarily two-fold.

"First, I believe the ghost stories from the past, aka, The Great Depression, scare and scar them more than the thought of inflation. With so much debt, the consequences of a depression are seen as far greater than the 'high-class' problems of inflation they believe/hope/pray they can contain. Pulling support away too soon is the main lesson they take away from The Great Depression.

"Secondly, without the benefit of hindsight which we are now judging them, things were still a little dicey with the pandemic and new variants popping up like whack-a-mole.

"I hold Congress and the president far more culpable for where we are. In fact, I recall Powell responding to Congress that the tools of the Fed alone were not sufficient to manage the impact of the pandemic, and that Congress needed to also act." – Paid-up subscriber John P.

"The Fed is like a drunk behind the wheel of a car. They don't see the curve up ahead until it's too late. By sheer luck they manage to just miss going into the economic ditch when they swerve, but they over-correct and again are heading for the economic ditch on the other side of the road.

The Fed is going in the ditch and taking the American Economy with them. That's when 'We The People' take their keys, charge them with DUI of the American Economy and throw them in lock down for good." – Flex Alliance member Kenneth S.

"Dear Mr. McLaughlin, The Fed did not act and will continue not to 'act' as they are determined to avoid a real U.S. debt default through an erosion of the U.S. $'s purchasing power.

"Further, many in the 'elite' class are desperate to start a war with Russia to save their status quo... whatever it takes as they say.

"Finally, (and to modernize an old quote attributed to many people in the early 19th century, including Will Rogers, although with a different descriptor) 'while it may be true that not all Democrats are Marxists you can be certain that all Marxists are Democrats.' The Marxists in the U.S. (and Democratic party) are plentiful and presently occupy the high ground... it won't be true forever. Notably Marxists never fight fair or civilly.

"The U.S. cannot thrive again until power and wealth declines dramatically in NYC, DC and San Francisco. Sometimes the American people are their own worst enemies... hopefully they wake up fully soon.

"We are no longer in Kansas." – Paid-up subscriber Harry W.

"Other than Paul Volcker, I don't believe we have had Fed Chiefs with the courage or smarts to act when they should." – Paid-up subscriber Robert T.

All the best,

Corey McLaughlin
Baltimore, Maryland
May 10, 2022