The Week That Matters (Sep 30-Oct 4, 2024)

"Freedom's just another word for nothing left to lose." Kris Kristofferson

This week the newsletter will argue the following:

1. The China rally has legs.

2. There’s only one way for Germany’s car industry to avoid a Nokia moment.

3. Buffet’s interest in Japanese financials is driven by a peculiar dynamic.

4. Tencent should be on everyone’s radar screen.

5. Kris Kristofferson was Best of America!

China: Does the market need to revert to the mean?

The global stock markets have a rich history of extreme short squeezes. Think Volkswagen in 2008. Think GameStop in 2021. But rarely do whole markets squeeze the way the Chinese market has over the last week.

This newsletter published a very bullish note about China on September 1st, 2024, but the author didn’t expect the magnitude of the move we have seen. He thought large cap Chinese tech stocks were cheap but the returns over the last week have been insane:

JD.com: +34.4%

NIO: +25.6%

BIDU: +19.3%

BABA: +17.8%

These kinds of moves are rare and often signal a turning point. We saw that in February 2009 and in April 2020. If you miss such moments, as a professional fund manager, you can seriously underperform.

The investment community is overweight private credit (YAWN!), and it is underweight public equity in emerging markets including China. With the Fed easing and China stimulating, that’s about to hurt. Fund managers will need to buy stock to keep up.

“Buy low; sell high” doesn’t always work the way you think. Charts with high RSIs are not always sells. The HSI Index looks like it might hit a bit of resistance on the chart this week, but the author believes it’s a buy on any pullback. (All else being equal in the Middle East).

Critical thinking is not common

The investment world is plagued by intellectual laziness. Value guys, like David Einhorn, complain the market is stupid because their outdated models don’t work anymore. Stanley Druckenmiller claims he won’t invest in China while President Xi is in power. Hubris?

The downgrades to Chinese growth in August by Goldman’s, UBS, and JP Morgan and the negative tone of their reports look horribly mistimed in hindsight. When you read them, they come across as unimaginative.

Wall Street had a decent dose of Schadenfreude seeing China in the situation Japan was in the 1990s. It made the guys in suits feel good. Upper echelons in the top investment banks probably were still smarting from their unsuccessful PE investments in Chinese financials in the 2000s. But such thinking often blinds people to the opportunities ahead and perhaps the current realities. Let the author explain.

As discussed on September 1st, China has two levers:

1. Real interest rates are too high as there is no inflation. Rates can go down to zero if needs be.

2. China’s economy is a lot bigger than it was in 2009 when it stimulated its economy and saved the world. It can do a $4-5 trillion fiscal stimulus package easily.

China is also winning many economic and commercial battles:

1. Its trade surplus is $80-100 billion a month.

2. Its saving rate is over 40%. The saving rate is less than 3% in the US.

3. It is leading in core growth industries: EVs, batteries, solar etc.

4. And in technology, it’s no longer a copier. It’s giving Silicon Valley a run for its money.

Zero Sum Thinking

The volume of anti-China legislation doing the rounds in Washington is ridiculous. There is a growing consensus that thinks about China in a zero-sum way. China must fail so the West can win. That’s just silly.

China can’t survive without the West and the West can’t survive without the factory of the world, namely China. Trump was right about onshoring (he pushed it before Yellen did) but he would be making a mistake trying to make North Carolina a hub for furniture again!

It’s time for new ideas. It’s time for new industries. We can, in the West, put our heads in the sand and ignore what China is getting right or we can acknowledge it, learn from it and work out how we can compete.

Rising equity markets in China might help. When people start to make money, they tend to pay attention to the good things going on in an economy. The author hopes the rally in China will get people thinking differently now.

It’s silly to write off President Xi. Under his watch, China has created a formidable EV industry from scratch in 20 years. He doesn’t want to repeat the mistakes of Japan as it will leave China vulnerable. He has also witnessed how Abenomics helped Japan get out of a deflationary funk. That means a big fiscal stimulus is on the cards.

Golden Week Channel Check

According to Smart Karma, early channel checks on China Golden Week suggest property sales picked up nicely, especially in Guangzhou and Shenzhen. China’s high yield property bonds saw a strong rebound. Vanke’s US Dollar bond due in November 2027 surged 49 cents to 70 cents.

Broader consumption appears mixed. Travel increased while consumers remained cautious. Poor sales of luxury goods stood out. There is clearly some work to be done to lift overall confidence.

No one knows if this rally in China continues, but if the author was a betting man (unfortunately, he is), he would argue we might all be China converts by the time we drink our yearly dose of eggnog. Stocks aren’t expensive, there is a catalyst, global fund managers are underweight, and the Chinese retail marginal buyer has regained his joie-de-vivre! As John Maynard Keynes said, “the markets are moved by animal spirits.” Let’s go!

Germany’s car industry: The Nokia Moment?

When the author was a kid, Germany was on top of the world. It at least made the semi-finals of each World Cup (Soccer!) and its machinery industry competed on a level playing field with Japan. But machinery parts are boring. It was Germany’s car companies that the German nation had most pride in. German cars were a work of art, full of precision engineering and amazing tech.

Mercedes-Benz was a pioneer in safety. BMW was at the forefront of performance. But perhaps, it was Audi (now part of Volkswagen) who led the charge. Audi even had a slogan that was poetic: Vorprung durch Technik (progress through technology). It was Audi that invented the all-wheel drive, the virtual cockpit and autonomous driving.

That all seems like a long time ago. Today, there is a pervasive sense of crisis in the German car industry. Volkswagen even told its workers a couple of weeks ago that it might have to lay off people. That never happens usually.

There are two issues:

1. German cars are not desirable anymore. They’re too expensive and perhaps, too complicated for people’s tastes these days.

2. The management of German car makers made a fortune in China for over 20 years. Unfortunately, that made them lazy. They didn’t innovate enough.

To be fair to the German car makers, it’s been a rough few years. It was hard to predict COVID and the collapse in Chinese consumer confidence (German car sales in China are way down). Of course, unless you worked in the secret service, no one would have had any idea that Nord Stream would be blown up. But that does not explain why Audi or any of the other German car companies didn’t become a leader in EVs, at least in Europe. It would seem there were some other reasons for that:

1. The German car industry was wedded to combustion engines. Like the Japanese, they turned their back on EVs.

2. Volkswagen went down a rabbit hole with a failed technology (look up Diesel Gate).

3. They didn’t focus on technologies related to batteries and software.

4. There was no attempt to expand the charging station infrastructure like there was in California.

What was interesting, though, was China was very explicit about making every car in China an EV car years ago. The German managers in China just ignored it. China was thinking in 5-year intervals while they were thinking about quarterly results. But no one could have anticipated just how quickly China would succeed in building a world class industry.

EU Tariffs

The EU this week slapped on tariffs on all the major Chinese EV companies and Tesla. Germany, which is the largest economy in the EU, opposed the resolution. German car companies still make a lot of money in China. They did not want any problems with its main market.

The tariffs aren’t high compared to the ones the US imposed but they don’t solve the problem. Europe is behind in innovation. It has to think through what it’s going to do to compete.

Chinese EV companies might relocate to Europe to get around the tariffs, similar to what Toyota and Nissan did with the UK in the 1980s, but the Chinese EV industry will continue to compound regardless. And consumers will always try to find a way to get the most reliable car at the most affordable price. We saw that with Japanese cars in the 1980s. We will see that with Chinese EVs in the 2020s.

EU must have a growth plan

The EU must start thinking ahead. Unemployment is going to be a big problem by 2030. The EU desperately need new job creating industries. Tesla has created 600,000 well-paid direct and non-direct jobs in the US. The much larger Chinese EV industry has created millions. A thriving EV industry in Germany could create a lot of middle-class jobs similar to what Volkswagen did for the Germans in the 1930s.

If Germany wants to compete, the car manufacturers will need help. There is no way the private sector can build what is needed alone. Becoming an EV company requires significant capital investment, advanced tech and a robust supply chain, particularly for batteries.

Henry Ford may have been an incredible entrepreneur, who built the traditional car industry on private money. That’s just not possible with EVs. That’s why Tesla has received so much government money and it has worked so well in a centrally controlled economy like China.

The German government should increase R&D tax credits by a magnitude of 100 to Audi, Mercedez Benz and BMW and subsidize the first few cars to make them affordable. Germany was once a leading manufacturing nation. Why can’t it be one again?

If it doesn’t get solved, this is going to fester and become a huge political problem. The car industry in Germany is 10% of the economy. And it’s a hot topic for the AfD (Alternative fur Deutschland) to run with.

Buffet and Japan

Fluctuations in the Yen have made Japan a tough place to invest recently, especially with China doing what it’s doing and emerging markets looking like they will break out. The new Japanese Prime Minister isn’t helping. He needs to learn a thing or two from the Imperial Family. Sometimes, it’s ok to just smile and say nothing. Leave the macro talk to the guys in dark suits in Kasumigaseki.

Japanese media has a term for fast money that frequents its shores. It calls them tourist/amateur investors. They tend to be a fickle bunch. As soon as another destination looks hot, they’re off and that’s what we’ve seen with recent outflows from Japan. The author gets it. China, at the moment, looks like a much better option.

But tides turn quickly in the investment game and one person who can still draw in the crowds is the PT Barnum of finance, Warren Buffet. Over the last week or so, there has been some chatter he might be looking at the Japanese banks and insurers as his next big Japanese investment. If he does invest, it will no doubt make front page news on the Financial Times. There will be a spike of excitement. But why would Buffet be interested in the banks and the insurers in Japan?