Talk Your Book: Will China Win the Trade War?

0:00Today's Animal Spirits Talk Your Book is brought to you by Crane Shares. Go to Craneshares.com. to learn more about their whole suite of products, including K-Web, that we're going to be talking about today. That's craneshares.com for more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:35Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:43Welcome to Animal Spirits with Michael and Ben. Last time Brendan joined us was the end of 2024. And I don't know if he was despondent or if I'm just making that up, I can't quite remember. But the average American investor had absolutely thrown in the towel on international stocks. We were like, literally, what would have to happen? What would have to happen for international stocks to outperform? And sometimes that's the way it goes. Yes. No one predicted trade war and falling dollar and all this other stuff. Deep seek. Yeah. And people were negative on China, too. Now I've seen the sentiment totally swing in the other direction of, wait a minute.

1:21Derek Thompson had a podcast asking the question, could this be the Chinese century? And it's totally flipped. So we got into all really great stuff with Brendan. from CraneShares. Micro and macro, would you say? We zoomed in and we zoomed out? Yes. Yes. You really wanted to know, are earnings driving these Chinese tech stocks or is it sentiment or, which is a legitimate question. So we talked about the trade war and the technology space in China and all this other good stuff. And Brendan's always great for this stuff from CraneShares. So here's our conversation with Brendan Ahern, CIO at CraneShares.

1:59Brendan, welcome back to the show. It's great to reconnect, Michael. Okay. We had you back on in December of 2024. The world looks a little bit different today than it did back then. I think maybe there was, was there, was tariffs in the air? There must've been, must've been, but not, you know, certainly more than we expected. Maybe let's start with this. Rewind to Trump presidency 1.0, his first term. How did Chinese stocks do during the first Trump administration? a shockingly well. I think, I think a, you had, you had volatility because you'd have these kind of tweet bombs that would come out.

2:41But, but for us with KWeb, actually that period, 2016, up through 2020 was one of the great time periods for performance for KWeb and Chinese equities. And that was under the art of the deal, right? You know, despite all the trade war, tech war, actually performed really well. So when we talked in December, I remember we were kind of grasping for what could cause international stocks to outperform. Like, it was hard to come up with a good idea at that point. Sentiment was on the mat. It was, I said it was the lowest sentiment I had seen in my 20 years of investing for international stocks. Everyone hated them.

3:24And now things have shifted. The dollar is down. International stocks are doing well. The trade war has seemingly benefited international stocks way more than the U.S. Do you think that this has legs or is it too hard to tell at this point? I think I don't think this is the end of American exceptionalism. I don't think it's the end of U.S. equities. But I'm more talking about the cycle. I agree like that. That stuff. Let's put that aside and debate the Roman Empire stuff later. But for now, like, is this has enough change that you can see that like, oh, actually, you know what? This this change has is better for ex-US than things were before just a few months ago.

4:05I think, you know, as we saw in Canada, where, you know, Pierre, the leading candidate, ends up losing to Carney because of national pride. And it's about to happen again in Australia. I was in Europe last week. And there's a lot of national pride is back. And there's about 17 trillion of foreign assets, foreign ownership of US stocks. and that some element of that is going to come back to local markets, if it's Europe, if it's Asia. And then I think later on, when the Fed does cut and the dollar declines because of just interest rate differentials, it'll give these non-U.S. equities a little bit of a further tailwind.

5:02And so, yeah, I think diversification is great again. I don't think it's some black and white situation. I think both markets in general can do well. But I think some of it will come back. And some of that's for national pride. Some of it's from valuations and just opportunity. All right. Let me ask you a basic dumb question. What drives the price of Chinese internet stocks? And the reason why I ask that is because I think maybe we take for granted that here in the United States, there's a confluence of factors. But ultimately, earnings are what drive stocks over any meaningful period of time.

5:44A stock is a share in a business. And if the business is doing well, the price will reflect that. Does the same hold true in Chinese stocks? And if not, what does drive performance? I think in the short term, you have media driven headlines, particularly for the names that are listed here in the US. A lot of that's geopolitical. And that's why actually we were seeing the Hong Kong lines arguably intraday do better. that you take the same piece of news and you give it to an investor in Asia on, say, about Alibaba, their reaction versus you give that same piece of information to a US investors about Alibaba, that's probably just less enthusiastic, which is why we've migrated a lot of our exposures out of the US names into the Hong Kong lines is we actually think they'll actually perform better.

6:47I mean, there's fungibility. So, right, like it's not like the two are totally disconnected. It's just intraday, given the same piece of information, the investors in Asia are more positive. And then the media narrative in the US is always so negative on China versus what people outside of the US consume, I think, is maybe more balanced or at a minimum less negative. All right. But I get it. You're talking on a very short term though. Does, do these companies benefit from the growth of the businesses or not? Oh, they certainly do. But if you have a lack of ownership, so Alibaba, just as an example, is like basically no debt.

7:42But they do have a US dollar bond. And how is it that the bond has outperformed the stock by like 60 % over the last four years? Say that one more time. Alibaba's US dollar bond has outperformed Alibaba's stock by like 60%. Whoa. Okay, why? Wait, so how much of that is currency? No, it's a US dollar. Oh, duh. Oh. Yeah, it's a US dollar. It's a fixed income investor gets out their 12C calculator and says, does Alibaba generate enough cash flow to pay back coupons and principal? And the answer is yes. I mean, they've got like 60 billion in cash. Unequivocally, yes. A stock investor, sediment matters.

8:34And that's where I think there's a geopolitical narrative about China that is really negative. If you get your news from Bloomberg or the Wall Street Journal or the Financial Times, the news on China is always negative. I mean, it's always negative. But how much of it is deserved? Well, I would preface some of what's happened is deserved, that arguably you've had a number of policy errors from the Chinese government. And there's a rationale for why they made these decisions. Internet regulation, zero COVID policy. That's what's happening in terms of real estate, which is the real issue in China today is the decline in real estate prices and the knock on effects on consumer confidence and domestic consumption.

9:28Those were policy errors. And you're seeing a pivot to rectify them. And so some of it is the derating because of these growth stocks stopped growing as quickly. And so some of that's just been that derating effect. And our belief is these stocks are just really, really cheap. You've got the second largest economy in the world stimulating. Ownership levels are nonexistent relative in the US, not so much outside of the US. And then we think the fundamentals of the underlying companies are actually going to improve. So I agree with you on the idea that the financial media is generally negative about China.

10:18But one of the surprising things to me about the trade war is I think that sentiment has kind of shifted in this way. I think a lot of people say, like, if there's going to be a steering contest, China has the ability to wait this out much longer than we do. Because the way that their system is set up, their government can essentially force the pain, I guess, on consumers and businesses much more easily than we can here. And a lot of people seem to think that, well, actually, China is way more important to us than we are to them. Do you agree with that sentiment? Yeah, I mean, I think that there's been a sea change over the last three, four months from the Wall Street Journal, you know, where they've been interviewing the CEO of Flexport, this logistics company.

10:58And yes, they're speaking about and obviously even President Trump, you know, he meets with Tim Cook and you have an exemption on electronics. You had the CEOs of Walmart, Target and Home Depot meet with President Trump. And lo and behold, Besant and the U.S. trade representative are going to Switzerland to meet with their Chinese equivalent. And I think just to your point, Ben, China is far less geared to the US economy for the US than I think people in DC really thought. I mean, that's why they've not bowed at the knee because they're like, you're more exposed with two thirds of your economy geared to consumption.

11:52And yeah, I mean, the port of Seattle, it's empty. There's no boats. And in early June, the tariff run up, you know, the front running of tariffs, those inventories run out. And that becomes a very big problem for the U.S. consumer, for the shelves. And yeah, I mean, it's yeah. So I agree. I think there's been a turning. And I think that's why the two sides, hopefully for both of them, are able to do a deal. Start with something small and build some momentum there. You mentioned that everything China hinges on their real estate. And there was obviously an overabundance of construction, supply, and it crushed sentiment.

12:49it. Where are we? Where are they, I should say, in the process? For real estate, it's location, location, location. So you're seeing the tier one cities, the rich cities, Beijing, Shanghai, Shenzhen, Guangdong, those cities are recovering. The lower tier cities, it's still a very, very bad, tough situation. And we in the US, our retirement savings are in the stock market. In China, it's in real estate. And so you've had a 50%, 60 % drawdown in your 401k or IRA. It really affects your consumption. And that's what's happened in these lower tier cities. And it explains why in September, you had this big movement from the government, and they continue to add to policy support to the real estate sector.

13:48And, you know, it's slowly coming back, but it'll take time. The other, I think the other big sea change in the sentiment towards China has been, I think for a number of years, most people just assumed, well, China is just kind of stealing all of our IP and technology, and they're not really creating anything themselves. And they're, it's just, we innovate here and then they steal it. But now I feel like the DeepSeek thing really was kind of a shot across the bow for a lot of people. And then the other thing is people are just looking at like, oh, my gosh, if you just look at all the infrastructure and everything that China builds, it just it seems like they're living in the future in ways that we just aren't.

14:24I think that's another way that people have kind of changed their tune. So in this tech arms race, like where would you pit things in terms of the technology sector in the U.S. versus China? And I guess that can be either the biggest stocks or just just sort of overall, however you want to take that. I mean, DeepSeek forces you to do the valuation comparison of your stocks trading at 40 times sales versus something trading 14 times next year's earnings. And, you know, I think the DeepSeek, you know, puts a little crack in that that huge valuation premium on U.S. tech versus China tech. But I think, yeah, I think definitely 16 years ago, these companies were counterfeiters, espionage.

15:11But they've moved way beyond that. And what's coming in terms of flying drones, autonomous vehicles, the robot thing is a real thing. and just the quality of their electric vehicles and the breadth of brands, the choice that they have in terms of not just EV hybrid gets kind of lost. They're arguably a lot further along than we are. But I like to think it doesn't have to be a war. It doesn't have to be, I win, you lose. And I think that can be maybe part of the art of the deal is can you bring a company like CATL, their big battery maker who had said they were willing to build a factory in Michigan.

16:01And Biden said no. And, you know, could that be part of a deal? And I think that's part of big picture. And you step back, the one U.S. investor that loves K-Web and China, you know, China tech stocks are technical analysts who are like, you know, higher highs and higher lows is an uptrend. And yeah, there's vol along with it. Michael's pulling up the chart right now. I can see him. No, I already had it up. I already had it up. So when are we going to get like the, is there ever going to be a deal to, because I keep seeing people say like, listen, I've toured the BYD cars before and they're amazing and they're very affordable.

16:41Why wouldn't we want to bring cheap electric vehicles here? And obviously it's a political thing. It's like, we don't want China to take over. Like, can you see a company like that ever being able to sell cars here? Is it just never going to happen? Yeah. I mean, the little secret is that BYD makes bus electric vehicle buses in California. They have a plan outside of Sacramento. They don't really publicize it, but they did. They did a deal with the state of California to supply buses, EV buses. So so it shows that you can do it. You know, they can hire Americans. And we've allowed the South Koreans and the Japanese and Fiat and others to come.

17:20So why not do this? You know, why not do the same? Or at a minimum, allow them to do a JV with Ford and General Motors. I mean, we actually are invested in a Chinese solar company that they want to build solar panels here in the U.S. And they've started down the path of buying property and they want to manufacture here. You know, they want to get their stuff to their best customer, which is us. And that's something that they've moved to Mexico, like other South Korean and Japanese automakers. You know, it's like Canada. You know, Canada doesn't make cars. GM and Ford make cars in Canada. Why not let the Chinese do it?

18:12Brendan, one of the interesting things about KWeb is, and I'm sure part of you likes this, part of you doesn't like this, is that it's on the list of ETFs, the top ETFs of dollar losses, which is an unusual and interesting list to be on because it shows that there's been a lot of money coming in despite the fact that it has been a rough and volatile investment, which again, I'm sure there's parts of it that you like. I'm sure there's parts that you don't like. I obviously don't like people losing money, but you love the fact that there's still a lot of confidence behind that. How does that make you feel?

18:49I want to put words in your mouth. I mean, one, I think people have found stock picking in the space really, really tough. And so I think some of that movement is money coming out of people saying, wow, like trying to pick the names is really hard. So I'm just going to buy the beta. But I think unfortunately, when you get the green light of like, oh, the coasts are clear, that's where the money has come in historically. God's honest, I was with an institutional investor yesterday. He was like, listen, I have a constant position in KWeb. And that way, when KWeb goes on these runs, like we saw coming out of January of 2024, in September and October of 2024, in more recently, January of 2025.

19:44Because I have a position when KWIP goes up, I trim it. And then when you get this pullback, I'll add to it. And he's like, literally, I've got the same position size. And he's like, I'm simply buying low and selling high through actively rebalancing. And that is the argument we continue to try to make with investors. Instead of waiting for some green light of like, oh, the coast is clear. When everything says it's time to buy, that's probably when you want to be lightening up. And yeah, I mean, I think we can't control when people buy and sell our ETFs. And yeah, I kind of wish people would buy more on weakness than buying on strength.

20:33Well, you're never going to fix that. Unfortunately, that's hardwired into our DNA. Exactly. Behavioral finance. My other question about the Chinese consumer, I guess, is you mentioned that stocks and bonds and investing here is just so much more of a big deal and consuming is more of a big deal. What would it take to get Chinese consumers to just spend more on retail and then get more involved in the stock market? Because you mentioned the idea of international investors. They've been pouring a lot of money into here in recent years. That's one of the reasons US stocks have done so well. So if they start to pull out and invest more in their home country, is it a cultural thing?

21:12What would it take to get the consumer there to be more involved in the market and spend more money and consume like we do? Yeah, I mean, the Chinese government is not socialist. They don't have the social safety net, like we enjoy. So, you know, they have de minimis unemployment, de minimis health care coverage, de minimis social security. And so you save out of necessity because you're responsible for, you know, your well-being. And then culturally, you know, you're not shipping grandma and grandpa off to the old folks home. You know, you're responsible for your family. And so you save a lot because you know you have these obligations for yourself and your family.

21:59And then I think it's something that I've experienced. My father was born in the late 1920s. And so he grew up in the Great Depression in World War II. And he was this uber saver. He got married later in life. So my mom is a baby boomer. And she's experienced nothing but great times economically her whole life. So it's like, oh, you know, you can spend. And, you know, that's a little bit of in China, you have your grandparents, people who experienced the grape leaf forward and experienced extreme poverty. And you're not even a full generation removed from that experience, like something that I experienced, which was don't spend money, don't take out loans, just save and invest.

22:48And, you I think that's an element as well. But it is also one thing Trump and Xi agree on, which is they do want to raise domestic consumption. And Trump wants it so that they buy more of our stuff. In China, they want to be less reliant on export-driven manufacturing, which is down to less than 20 % of GDP. It was like 36 % in 2009. So it's maybe an area that when the sides meet, that they can have some mutual agreement. How is the Chinese economy doing? I know there's like really – I think Vanguard did a piece about this. The stock market is not the economy is really, really true in China. There could be a giant disconnect.

23:35So maybe not super relevant for K-Web, but just curious. How is the Chinese economy doing? Well, no, I mean, I mean, you know, I mean, and just to answer your question, but, you know, we would argue K-Web is the transmission vehicle for domestic consumption in China, right? That the underlying companies, e-commerce benefit from. So that's part of why we're, you know, we're constructive. I mean, obviously, we're we have our bias, but but you're constructive on K-Web. Yeah, exactly. Yes. Highly biased and self-serving. But I think the economy, in your head, you'd think buildings are on fire. When I was there in January, I'm going back very soon.

24:22It's just not at all. And yeah, there's a bias. I'm going to rich cities, Hong Kong, Shanghai. But it's literally So they're chugging along. It's just consumer confidence is low because of this downdraft, and that's slowly improving. What is their sentiment that you get from your contacts and being over there? What is their sentiment of the trade war? Are they kind of thinking like, why are we doing this? Are they nervous and anxious about it? What is the sentiment in China know, from that perspective? I mean, I think the Chinese government is playing tough because they've done the math and that they know we're more reliant on them than the other way around.

25:10And but but it will certainly affect there are, you know, geographical areas that are very much dependent upon export driven manufacturing. Those geographical areas will suffer. You know, they have this kind of Christmas town, Christmas tree lights, Christmas ornament, uh, town, you know, city and, and that, that will shut down because, you know, the tariffs will just make it, you know, uneconomical. Uh, but a lot of China is not, not geared that way and it'll, it'll be just fine. So I think, I think there's more of it's what tariffs are irrational and, uh, you know, So, you know, I mean, you know, that's where unfortunately this is the most expensive history lesson and economics 101 lesson ever given.

26:01Because if you just studied history, you'd be like, oh, wow, Smoot-Hawley, Great Depression. You know, if you studied economics, you know, they call them economic laws, you know, comparative advantage. And so that's where it's really, you know, I think it's, you know, I mean, I think it's really unfortunate. that you're willing to play kind of Russian roulette with American investors' savings to try to drive this issue. I mean, it makes no sense to me. And I think that's the view in China. I mean, I was recently in Europe and people were just, we've been your allies, we've been your friend and you're giving us the middle finger.

26:46Like, you know, how can we who are poor and, you know, buy as much from you, from us? Like, you know, it just doesn't make any sense. And in Europe, people were, you know, it was a big topic of discussion. Let's end with this. We mentioned DeepSeek earlier a bit. How does the semiconductor chip war, all that stuff factor into the future of Chinese internet stocks? I mean, they've had to deal with the Biden export controls. There was clearly a lot of inventory front running. But I think a lot of those banned chips, they end up going through other countries and making their way. But it's forced local companies to step up their game.

27:44And that isn't going to happen overnight. But DeepSeek, if you believe their claims, they were able just to use more chips. Kabul, instead of using one NVIDIA, used 10 Huawei chips and the computing power works out. Okay. So let's put you on the spot here. Does the trade war help or hurt these Chinese tech companies? Or is it doesn't really matter at all? Where do you stand? I mean, for US investors, it's career risk for professional investors to buy something with China in the name. And I think that's where that is not true outside of the US, which is why I spend so much time in Asia, in the Middle East, in Europe, I'm going to places where institutional investors are not beholden to this media narrative or the geopolitical.

28:42And a lot of parts of this world are much more geared to the Chinese economy than to the US economy. And any commodity-producing country cares a lot more about China than the United States. And those investors will come back and arguably are coming back. But I think the one US investor that is involved besides the technical analysts are the hedge funds that a lot of prominent US hedge fund managers said. And why? Because they can hedge, they can trade. And so I think these big swings in volatility in K-Web, you can do what this one professional investor is doing, which is just a small piece of his portfolio.

29:26He's letting it ride up and down. And, you know, but others, you know, we did do this call writing fund off K-Web called CLIP. K-LIP. Yeah, K-LIP. Well, that's where some of you are like, the K-Web. I'm like, what? The K-Web? And they're like, K-W-E-B? I'm like, K-Web? And they're like, yeah, the K-Web. I'm like, what? So K-LIP, I've not heard that, Michael. But like, you know, we're just going to write calls to monetize that. Or we got KMQ, where I'm like, hide the China, right? KMQ is the EM version of KWeb, and it includes the KWeb companies, but it includes Mercado Libre and other non-US companies in that space.

30:08And you can hide the China and get the exposure. And yeah, again, I don't think the volatility will go away because of this geopolitical where it's really tough to have that China light item. People throw stuff at you. But you can take advantage of it. And I think for those that, you know, I always say it's the Danny Kahneman. Are you thinking fast or you're thinking slow? If you'd spend the time and think slow, there's a lot of really good opportunities there. But even if like, I always think that the narrative is usually if the dollar is weak and that's what it seems like they're trying to do, whether they mean it or not, that's typically good for emerging markets, right?