China Stock Reckoning

It was a bad day for Chinese stocks yesterday. Pinduoduo (NYSE: PDD) got whacked for a 30% drop after it reported earnings that were, um, not good. To make matters worse, the CEO said that revenue and profits must “inevitably” decline as China’s economic growth slows. And the “inevitably” decline comment wasn’t just a one-off – he said it 8 different times…

The question we ponder today is: just how much of a problem is China’s economy?

Well, as you know, Hammer and I have been a little worried about the U.S. stock market for a couple of months now. And while it’s all well and good to talk about stock market valuations and weakening economic data, the simple fact is, it takes a shock to the system to push the U.S. economy into recession. China could fit the bill, and some of the reason is directly related to yesterday’s Pinduoduo earnings, so let’s dig in…

For the last 20 years, in order to speed up its industrialization process, China’s government has invested directly in a range of production – steel, solar, electric vehicles, housing, etc. The idea is to foster jobs and raise standards of living to the point that a consumer-led economy can take over.

The problem is that production in each of those sectors has totally outstripped Chinese domestic demand. China has too much steel, too many solar panels and EVs, and way too much housing.

If you’re making too much stuff already, it’s bad for employment. That’s why China’s “official” unemployment rate is 5.2% and its youth unemployment rate is reported to be a shocking 17%.

China would love to be able to dump steel, solar panels, and EVs on the global market at below-market rates. That’s why the U.S., EU, and Canada all have high tariffs on Chinese stuff. So that’s not going to work…

China’s real estate market is equally messed up, if not more so. For at least a decade, Chinese people have used real estate as savings accounts. They prepay for condos and apartments that are expected to be stores of value. But, it’s estimated that China has built twice the amount of condos and apartments that its population can occupy.

There’s no need for the Chinese people to fund more building, which means developers are strapped for cash, aren’t building, and are defaulting on debt payments. And the glut of condos and apartments means that there’s no one to sell existing property to. All those “savings accounts” are stuck.

Finally, China’s population is in decline. Demand will fall further and the real estate (and savings) problem will get worse.

There’s no way out for China. (Even though, if there’s one export that China is succeeding with, it is weapons to Russia, Africa, North Korea, etc.)

Security Blanket

It might seem like the trend toward reshoring and moving supply chains out of China is insulating the U.S. from China’s problems…but the truth is a little different.

GM used to do about half its sales in China. In the last few years, its sales volume in China has been cut by 50%. Its China business is now losing money

20% of Starbucks stores are in China. Starbucks’ sales numbers for China fell 11% in August

Apple iPhone shipments in China are down 6.7%, and its market share fell from 16% to 14%

In June, Tesla reported a 24% drop in China sales

Since supply chains started getting rerouted after the pandemic, the U.S. stock market has mostly turned a blind eye to China’s economic problems. The word “contagion” started popping up last year when China’s Evergrande property developer went bankrupt with $300 billion in debt(!), it didn’t last.

But it wouldn’t be a surprise if Chinese stocks – and China’s economy – get back in the spotlight soon.

You Can Hear a Pinduo-Drop…

A few months ago, two prominent hedge fund managers announced to the world that they were loading up on China’s e-commerce heavyweight Alibaba (NASDAQ: BABA). They were Appaloosa Capital founder David Tepper and “Big Short” trader and Scion Capital founder Michael Burry.

Now both guys have some cred. Burry made himself a fortune by being one of the first to recognize and predict the subprime meltdown and the Great Financial Crisis.

Tepper made his bines being relentlessly bullish coming out of the Great Financial and bought the Carolina Panthers a couple of years ago…

Pretty nice of them to let you know about the opportunity with Alibaba, not.

When hedge fund guys start telling you what their favorite stocks are, you should immediately ask why. Sure, it’s always fine to understand why an investor likes certain stocks. But more importantly, the question is: why are they telling you?

Are they looking out for the little guy? Do they just wanna help investors out?

Or are they hoping to stoke some bullishness among individual investors in order to get some buying going and push the stocks higher?

Hedge funds have one goal, and it ain’t to help you out. Tepper and Burry are in it to make money. Getting you to buy stock they already own is a pretty good way to do that.

In mid-May, regulatory filings showed that Tepper’s Appaloosa LP bought $800 million worth of BABA stock in the first quarter (January – March 2024). BABA shares traded mostly between $70 and $80 during those three months…

So when word got out, BABA shares rallied up to around $90. Not bad.

But Tepper didn’t just buy Alibaba. He also bought JD.com (NASDAQ: JD), Temu owner Pinduoduo (NYSE: PDD), and Baidu (NASDAQ: BIDU).

Kinda all in on China…

You may have heard about the e-commerce company Temu recently. They’ve done very well with direct-from-China manufacturer shipping to offer low costs and circumvent various trade restrictions.

Pinduoduo is the parent company of Temu. And it’s warning yesterday that revenue and profit will “inevitably” decline — largely due to weak consumer spending in China — is a problem.

I’ll bet you dollars to donuts that the next regulatory filing from Appaloosa shows that Tepper has at least trimmed his holdings in all of these stocks if he hasn’t bailed on them completely. Same for Burry.

And if Chinese stocks start falling more than they already have, China’s economic problems could come right back into the spotlight.

Cheers,

Briton Ryle
Chief Investment Strategist
Outsider Club

X/Twitter: https://twitter.com/BritonRyle

Latest Articles