The China Explainer, Part I

Read this even if you hate China... What you should know about China's stimulus plans... Brendan Ahern from KraneShares explains the impact... Watch our conference with a Livestream Pass... Mailbag: Your 'inverse Fed fund' ticker ideas...

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You've likely heard about the Chinese stock market lately...

It has been getting some attention in the financial world, and I (Corey McLaughlin) wrote about it as part of Monday's edition.

Major Chinese stock indexes have spiked (and pulled back some in the past few days). This follows last month's announcement from the People's Bank of China ("PBOC") – the equivalent of the U.S. Federal Reserve – of sweeping monetary-policy changes aimed at boosting activity in the world's second-largest economy.

The PBOC has lowered a host of interest rates in the country, cut the minimum down payment for new homebuyers to as low as 15%, and gifted liquidity to financial firms in the country for them to put to work in the stock market. More "juice" may be coming from the fiscal part of the equation soon.

Why? Well, in the past few years, China has seen plummeting consumer confidence and angst amid "zero COVID" lockdowns... a shaky, at best, real estate market... extended deflation... and declining foreign investment.

The recently announced policies from the Chinese central bank are aimed at easing those troubles.

Whether it all "works" remains to be seen, but it certainly gave a short-term boost to Chinese stocks. For instance, since a recent low in early September, the iShares China Large-Cap Fund (FXI) is up roughly 30%, even with a 10% drawdown this week.

Now, before you close this e-mail...

I know hearing about China makes some folks want to break whatever electronics are in their reach and lament American jobs lost over the years to China and other emerging markets.

But whether you enjoy Chinese financial news or not, China matters to the global economy... And it influences the direction of markets and companies you and I are invested in, either directly or indirectly.

China's population is nearly 1.5 billion, which is about 17% of all the people on the planet.

We've likely seen the influence as part of the pop in oil prices lately – China is the world's second-largest consumer of oil. And, of course, the relationship between the U.S. and Chinese economies is undeniable, even if complicated and fraught with political concerns.

So, with all this mind, I was beyond pleased when I found out Brendan Ahern, chief investment officer of KraneShares, was joining Dan Ferris and me on this week's Stansberry Investor Hour podcast.

Talking to an expert...

KraneShares has more than $10 billion of assets under management, Brendan told us. About half of that is invested in its popular China-focused exchanged-traded fund ("ETF"), the KraneShares CSI China Internet Fund (KWEB) and other emerging-market investment vehicles.

Now, first off and importantly, Brendan acknowledged to our listeners that investing in China and other emerging markets is volatile...

I say to people... we should be just a tiny part of a portfolio. We're super volatile... but I think there's an opportunity [in China]. We've had a big run here. Maybe you wait for pullbacks and corrections, inevitably.

Brendan also writes a free daily newsletter – China Last Night – that gives a great easy-to-understand view on developments over there. As Dan and I learned, the newsletter was an idea that Stansberry Research icon Steve Sjuggerud suggested to Brendan.

We can see why. In short, Brendan is a self-effacing expert in the Chinese market. As he explained...

The most important thing we do is try to provide a balanced, data-driven perspective on what's happening in China's economy and capital markets. We're not into selling greed or fear or apocalypse.

We're data junkies and we want to provide that to investors so they can make a rational decision whether or not to invest with us... Emerging markets inherently are very volatile, but it's really about the data and the research.

We go to China. We meet with the companies we're invested in and we try to provide those perspectives where I think in general, Western media is a source of disinformation. It's not a good source for what's going on over there.

In this week's Investor Hour, Brendan gave us what I will describe as a "China explainer" about what we should know about the Chinese economy, what folks should know about Chinese stocks, and other pertinent topics like a potential war in Taiwan and the unconventional way to collect data about the Chinese economy...

Below, you can read an edited transcript of just the first part of our conversation. We'll share some more tomorrow.

But if you'd rather just listen to or watch the whole thing, you can do so now on our YouTube page, listen at InvestorHour.com, or find the episode – and all of our shows – on popular podcast platforms like Spotify or iTunes.

Away we go...

Dan: So, China's central bank did some stuff recently, huh? And Chinese equities took off like a rocket, so something big is up, right?

Brendan: Finally... and [the PBOC] clearly waited for the Fed to cut rates. Why did they wait? Well, currency movements are driven by interest-rate differentials... If they had cut before the Fed, the renminbi, their currency, would de-appreciate versus the dollar and U.S. politicians would say they were manipulating their currency. So they waited for the Fed.

But it doesn't really have much to do with the U.S. economy, or U.S. politics. They're doing this because the situation in China has gotten... not dire, but it's not going great. And they're finally coming up with a prescription to a number of problems that have weighed on the economy, stock market, real estate market, and consumer confidence.

The end citizen in China has kind of been giving the government the thumbs-down, and this is the first movement... of getting off the proverbial pot.

Dan: Do they get their thumbs cut off when they do that in China? I mean, are they allowed?

Brendan: The government is attuned to public sentiment, and there's examples of that. A lot of the reduction in pollution in China, particularly in Beijing, is because people got angry – like, it's snowing in summer and that's not snow, it's ash. That was the case eight years ago. That's no longer the case.

I had asthma as a kid, and I actually jogged in Beijing four years ago. It just shows they are aware of the public's view. Every government globally, if there's economic demise, you get fired as a politician. That was true with Boris Johnson or President Trump because of the collapse of the economy because of COVID, or the Asian Tigers in the late '90s. If there's economic collapse, there's regime change, and that's true in China.

The government is acting because of very, very low consumer confidence in China driven by the fall in real estate prices.

Dan: What do you make of how the market has reacted to the PBOC's moves? Is it an overreaction?

Brendan: Well, they cut all these interest rates and are very focused on stabilizing real estate prices because two-thirds of urban household wealth is in real estate. And that's why consumer confidence has come down, and that's why domestic consumption has been so low.

So if you can get property prices up, you raise consumer confidence, you raise domestic consumption. But they also said, we want to raise the stock market because the stock market is an indicator of animal spirits of consumer confidence. And the PBOC said, we're going to give 500 billion renminbi – about $70 billion – to insurance companies, brokerage firms and mutual funds to buy stocks... and if that doesn't get the stock market up, we're going to give them another 500 billion... and if that doesn't get stock markets up, we'll just give them more.

It's like you have this huge flashing green light that is mainly focused to Shanghai and Shenzhen... This is very much directed to mainland China stocks, 95% owned by investors in China. There are also Chinese companies in Hong Kong and U.S. [American depositary receipts ("ADRs")] as well, and they've had a really, really strong reaction... partially driven by a lot of short selling [that had been going on]. Those investors and hedge funds who were short China just got run over. They're going to get carried out. But more importantly, why you've seen this reaction is that investors globally have been very underweight China.

China's economy is $18 trillion GDP, but India at $3.5 trillion actually was a bigger part of global indices. That makes no sense, but it just shows this there's this incredible underweight to Chinese equities globally.

Some of that money that came out of China went into U.S. tech or India or Japan. What you're seeing is a rerating back in, and that's where we've had this incredible reaction. There's going to be pullbacks and corrections, but I think if you believe they're going to stick to this stimulus – and we only saw monetary... the fiscal is still coming, the details are still pretty vague – this rerating we're talking about is a lot of money coming back into China not today or tomorrow, but in the next quarter, months, and years...

Dan: The idea of underweighting the $18 trillion versus the $3.5 trillion in India... that intrigues me. If that's ever fixed, look out. That's a lot of capital...

Brendan: It'll rectify itself, but it will take time. A hedge fund or individual investor can change its opinion. But think about the pension funds and endowments. They got to get the investment committee [together], talk to trustees or directors, and that's global.

That's why I'm more constructive of in the long run, that if more fiscal support is coming, that supertanker of underweight doesn't turn on a dime.

And some of the problems in China aren't going to solve themselves overnight. Real estate is an issue, and they're starting to fix it, and there'll be ups and downs in that effort...

China has urbanized over the last 40 years, moving people out of rural areas into cities in order to raise their standard of living, giving them access to health care and education. And that's led to overbuilding...

For the first time ever, because of the concern about overlevered developers in China, the music stopped and that led to property prices falling for the first time in people our ages' life. That's really weighed on domestic consumption and consumer confidence, which is hurting the economy, which is why they're doing this pivot – really a 180 – to try to get real estate prices up.

Corey: How do you think the stimulus "works"? And can you talk more about why this might not be it?

Brendan: We've really seen the monetary-policy bazooka... but what we've only seen the start of is the fiscal stimulus. They've said, we're going to provide subsidies to auto purchases – hybrid, electric, and internal-combustion engines – home appliances... But it's only really the start.

What we think will come out over the next several weeks is them saying, we're going to put 1.5% to 3% of GDP into stimulus geared to raising domestic consumption... They need to get people spending. Why they're doing that is, what's worked has been export-driven manufacturing. And now they see their biggest client, the U.S., is cutting interest rates.

They [China] know the demand for export-driven manufacturing from China to the U.S. – some of that may be through Vietnam, Malaysia, Indonesia, or Mexico... is going to slow, which is why they're pushing this button right now.

Everyone thought they wouldn't do anything before the [U.S. presidential] election, but I don't think they care about the election. They care about their own economy.

Corey: That brings me to a point you made earlier about the Western view on China... What do the Western media and even investors and analysts have wrong about China?

Brendan: One, U.S. businesses are doing really well in China and every U.S. investor is implicitly invested in China. If you think about Tesla, 25% of revenue [is from China], or Apple 16%, or ExxonMobil 12%. Qualcomm, Texas Instruments, it's upwards of two-thirds. So, businesspeople and investors have been getting along just fine, and the diplomats from both sides have not, and that should make every investor nervous.

The media plays with some of what D.C. wants. But if these politicians can't get along, you know that's a big problem because a lot of U.S. companies are really dependent upon China... There's a lot of political rhetoric that's not really economic reality, like tariffs.

The Chinese government doesn't write [the check for American tariffs]. Walmart, Home Depot, Costco write the tariff check to the U.S. Treasury. And a lot of that stuff we can't build here, we shouldn't want to build it here. China exports deflation, and we're a beneficiary.

So, some of the narrative doesn't really fit the data. And that that should make every investor nervous a little bit if you own Apple or Nike or Boeing or Caterpillar. No China, big problem.

Dan: Is there something you like better to buy than something else in China right now? Or is it really [that] because of the nature of the easing and the fiscal stimulus to come, you're buying the baskets?

Brendan: You want to buy the market... It's amazing, you know. There's over 5,000 stocks listed on the Shanghai and Shenzhen Stock Exchange, and four went down [on Monday last week]. Hong Kong was similar, no stocks went down.

Our communication to investors is you have this onshore China, Shanghai and Shenzhen... This is our KBA Fund [KraneShares Bosera MSCI China A 50 Connect Index Fund] versus KWEB [offshore, Hong Kong] – and there's a lot of other China ETFs from competitors out there, so don't just look at our stuff.

But what a lot of what the PBOC stimulus has done so far was for KBA names... because the domestic investor owns those same stocks. Then you have foreign investors, they really want these growth stocks like we hold in KWEB, the Alibabas, Tencents, and Meituan. And the foreign investors will kind of come back to those growth names in Hong Kong.

Self-serving, I own them both because I can't predict which one's going to do better. I've lost a lot of money over the last three and a half years in them both, and I'm not quite back to even but I'm getting there. But I think you'd have to say, "What's going to drive this?" And there's arguments for both camps but they're not interdependent. They're very different investor bases, so they can do very different things.

You have to say, "Is the domestic going to get really excited?" And I would say I think so. Back in 2014 and 2015, you had a big, big bull market in mainland China. It got a little out of hand in terms of leverage. They're not going to let that happen again. But also, foreign investors are really underweight China. Some of that money coming back in is real money, and that will take time.

I have to also say China has made huge policy mistakes over the last few years, huge PR blunders... why these stocks have done so badly, why they're so underweight. They're arguably trying to change some of that.

We'll share more of this conversation tomorrow...

In tomorrow's Digest, I'll include a portion of our transcript in which Brendan goes on to discuss the prospect of a Chinese invasion of Taiwan, unconventional ways of collecting economic data, and more about his outlook for the world's second-largest economy and Chinese stocks.

And like I said... if you don't want to wait, you can already catch our full interview on the Stansberry Investor Hour. 

New 52-week highs (as of 10/8/24): Automatic Data Processing (ADP), Atmus Filtration Technologies (ATMU), Alpha Architect 1-3 Month Box Fund (BOXX), Commvault Systems (CVLT), Fair Isaac (FICO), Home Depot (HD), Houlihan Lokey (HLI), Lockheed Martin (LMT), Motorola Solutions (MSI), Oracle (ORCL), PayPal (PYPL), Sprouts Farmers Market (SFM), Toast (TOST), Trane Technologies (TT), The Trade Desk (TTD), and Vertiv (VRT).

In today's mailbag, a few suggestions for an "inverse Fed fund" ticker, which was discussed in yesterday's mail... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Inverse Fed Fund Ticker Symbol: SCAM." – Subscriber Gary S.

"Corey – going for the low-hanging fruit here... FEDUP." – Subscriber Jan W.

"Here's my two cents worth: FDIC – Federal Debasement Implementation Cabal." – Stansberry Alliance member Stephen G.

"Corey, I have the perfect ticker symbol for the Inverse Fed Fund. NOCLU, which is short for No Clue!" – Stansberry Alliance member Kenneth S.

All the best,

Corey McLaughlin
Baltimore, Maryland
October 9, 2024