China Stumbles While the World Rumbles

Tomorrow marks the start of China’s Lunar New Year, meaning it’s out with the Rabbit and in with the Dragon… but all eyes remain on the Bear. And no, I’m not talking about the hit Hulu series, but Russia.

In case you’re not aware, former Fox News host Tucker Carlson posted his interview with Russian President Vladmir Putin on X today. Despite it being over two hours long, I urge everyone to go watch it, not because I place any value in what Putin has to say but to look into the mind of one of America’s and the Western world’s chief adversaries.

When Carlson asks Putin why he invaded Ukraine, Putin launches into a half-hour-long history lesson that begins in the ninth century. Although the president’s command of 1,200 years of Eastern Europe history is impressive, it’s not a serious answer as to why an invasion had to occur in the year 2022.

Carlson is right to ask if all countries should go back to their centuries-old borders, to which Putin says they’re welcome to try.

Ukraine declared its independence in 1991 after the fall of the Soviet Union, along with Lithuania, Belarus, Crotia, Slovenia and other former Soviet states. It would be difficult to make the argument that Ukraine is a model country—as the poorest nation in Europe, it still struggles with corruption—but after more than 30 years of self-rule, it’s just as entitled to defend itself from violent aggressors as Israel is.

That’s true no matter a person’s opinions on Putin, Carlson, Ukrainian President Volodymyr Zelenskyy or President Joe Biden.

From Boom to Bust

A little over a year ago, the world watched as China reopened its doors after three long years of strict pandemic lockdowns. Expectations were high for a robust economic recovery, fueled by pent-up demand and consumer spending.

The reality has been starkly different. Despite a bustling travel season around China’s Lunar New Year—with a record 9 billion domestic trips expected, 80 million by air—the anticipated economic rebound has largely failed to materialize, even as world markets have surged to record to near-record highs.

This downturn appears not to be just a temporary blip, but a sign of deeper structural issues within the Chinese economy. The nation’s gross domestic product (GDP) reportedly grew 5.2% in 2023, an admirable print at first glance, but it masks underlying challenges. A closer look reveals a significant slowdown from the pre-pandemic era of consistent +6% growth. Select industries such as electric vehicles (EVs) saw remarkable sales in China last year, but this strength hasn’t been enough to offset serious weaknesses in other sectors, particularly real estate, which remains a major drag on the economy.

Our decision to close the China Region Fund last year was a move predicated on recognizing early signs of these economic challenges. It’s a decision that, in hindsight, has been vindicated. The ongoing property sector slump and regulatory uncertainties have further exacerbated investor apprehension, leading to a significant outflow of $68.7 billion in foreign direct investment (FDI) for the first time since 2018.

Chinese equities continue to underperform. Both mainland stocks and those listed in Hong Kong ended 2023 with losses, even as other Asia-Pacific markets rallied. Remarkably, Japan’s Nikkei 225 is poised to hit a new all-time high after 34 years.

This year isn’t off to a great start for Chinese stocks, either. The CSI 300 shed over 7% in January, while the Hang Seng lost over 9%.

“China seems to be divorced from the rest of the world,” Steve Sosnick, chief strategist at Interactive Brokers, told Bloomberg. “Part of the lack of equity response is that the global economy is doing OK without China.”

Mexico Surpasses China as America’s Top Import Source

Indeed, in a shift not seen in over 20 years, Mexico outpaced China last year to become the top supplier of imports to the U.S. This change highlights the escalating strains between Washington and Beijing, alongside American initiatives to source more goods from closer, more allied nations.

Recent data from the Commerce Department indicates that imports from Mexico to the U.S. increased nearly 5% from 2022 to 2023, reaching over $475 billion. Conversely, the import value from China saw a sharp decline of 20%, falling to $427 billion.

Will China’s Steps to Stabilize the Market Work?

Efforts to stabilize the Chinese market have so far failed to lift investor confidence. On Tuesday, the China Securities Regulatory Commission (CSRC) announced plans to halt the practice of brokerages borrowing shares to lend them out and to limit the scope of what’s referred to as the securities re-lending market, in a move aimed at reining in short-selling activities.

This came a day after the regulator vowed “zero tolerance” against short sellers, warning them they could “lose their shirts and rot in jail,” according to reporting by Reuters.

These regulatory steps were introduced after the Chinese government declared in October 2023 that it would issue 1 trillion yuan ($140 billion) in Chinese Government Bonds (CGB) to support local government finances and fund infrastructure projects in areas affected by natural disasters over the past year.

The move was meant to send a signal to global markets that China is “pro-growth” again, but as Morgan Stanley’s Schuyler Hooper writes, the strategy is seen as “merely a repeat of China’s old policy playbook, where they rely on investment to prop up ‘economic’ growth, while growth in consumption, export, property and private investment remains sluggish.”

The risk, Hooper points out, “is a short-lived cyclical rebound amid a longer-term secular slowdown” in the Chinese market.

The Critical Role of Diversification

The Chinese government faces a daunting task in addressing the deep-seated issues within its economy. Chaos in the real estate market, local government debt and deflationary pressures are significant hurdles to sustained growth. Geopolitical tensions add another layer of complexity.

The situation serves as a reminder of the importance of diversification and the need to remain agile. I believe it’s more important than ever to rely on sound investment principles and a diversified portfolio.

Index Summary

• The major market indices finished mixed this week. The Dow Jones Industrial Average gained 0.04%. The S&P 500 Stock Index rose 1.35%, while the Nasdaq Composite climbed 2.31%. The Russell 2000 small capitalization index rose 2.40% this week.
• The Hang Seng Composite gained 1.57% this week; while Taiwan was up 0.20% and the KOSPI rose 0.18%.
• The 10-year Treasury bond yield rose 15 basis points to 4.172%.

Airlines and Shipping

Strengths

• The best performing airline stock for the week was Frontier, up 39.9%. Allegiant’s fourth quarter 2023 earnings per share (EPS) was $0.11, compared to consensus’ $(0.23) estimates, largely on lower drag from Sunseeker versus consensus. The airline segment’s fourth quarter EBIT of $20.6 million was slightly ahead of the $19.1 million consensus.
• According to Morgan Stanley, the world’s 13 largest container shipping lines significantly improved their schedule reliability in 2023. On-time performance increased from 42.6% to 62.1% in 2023, an improvement of 19.5 percentage points, according to Sea-Intelligence’s Global Liner Performance report, which measures the ability to arrive on time for the world’s 13 largest container carriers.
• Frontier Airlines’ fourth quarter EPS of $(0.17) compares to consensus of $(0.24), with the beat versus consensus driven by better costs and slightly stronger revenue. Aircraft utilization was 11.3 hours in the quarter, consistent with the third quarter of last year, but down slightly from 11.5 in the same quarter of 2022.

Weaknesses

• The worst performing airline stock for the week was Azul, down 10.8%. According to Bank of America, airline stocks declined 1% in January compared to the S&P 500’s positive 2% jump after meaningfully underperforming the market in 2023. First quarter 2024 revenue outlooks have generally met or exceeded their expectations, while valuation multiples have moved lower in January on other industry risks and events.
• Maersk issued a fiscal year 2024 (FY24) outlook that was below market expectations and suspended its buyback program. The company guided to FY24 $1 billion to $6 billion EBITDA and -$5 to $0bn EBIT, noting that the high and low ends of the ranges assume that Red Sea disruptions are resolved in the first quarter of this year or last the whole of FY24, respectively.
• According to JP Morgan, Chinese airlines’ fourth quarter results came in below expectations as Big Three net loss of Rmb4B was wider than prior fourth quarters seen before the pandemic (2016-2019). The market has very likely priced in the anticipated weakness caused by the off-peak, post-holiday period in the fourth quarter of 2023.

Opportunities

• ISI tracks web traffic to airline websites as a proxy for bookings. Airline web traffic was up 3% year-over-year for the week, compared to up 4% year-over-year in the trailing four-week period.
• According to Morgan Stanley, ZTO experienced a significant de-rating with consensus 2023 and 2024 earnings having downward adjustments by 1% and 5% from their respective peaks in the past six months. ZTO is trading at a 30-40% discount to global peers. The group sees a potential inflection point that ZTO’s earnings growth can return to double digits in the first quarter of 2024 in a bull case or in the fourth quarter of this year in a bear case and trigger a re-rating.
• According to Bank of America, Frontier raised capacity by 440/830 basis points (bps) in April and May, and nearly 11% in June and July. While the April and May additions benefitted…