The Challenges of the China Market

0:01Tyler Crowe:The challenge of China's market today on Motley Fool Hidden Gems Investing.

0:12Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime pool contributors Matt Frankel and Jon Quast. So we're going to really dive into the challenge that a lot of companies have been facing in China recently. recently we discussed it yesterday on the yesterday's podcast related to nike's earnings we're going to scratch that a little bit deeper because there's a lot more companies than just nike they're suffering this problem but before we do that it is july 2nd well we're recording on the first but hey you know what for you guys it's the second it means we're more than halfway through the year and so far the s &p 500 has been a wild wild place we've had some incredible performance up and down the spectrum.

0:55Tyler Crowe:And I got to say, guys, I think so far this year, I think I've seen the widest spread of outcomes in the S &P 500 in a long time.

1:04Matt Frankel:Well, yeah, I mean, first and foremost, if my math is right here, we had 22 stocks, double or more in the first half of 2026. Now, I'm talking about 22 stocks among the constituents of the S &P 500. That doesn't seem normal to me. I haven't checked the historical data, but having that many stocks, double or more. I mean, we look at some of the higher end stocks, the top five. I mean, it's far more than that. So to have the these are the largest U.S.-based profitable companies to have this many going up this fast. It just is remarkable.

1:40Tyler Crowe:To your point, too, John, it's not just like, you know, the smallest companies going from like 20 billion to 40 billion. This is like Micron going from$500 billion to a trillion dollars in six months or something. Not the specific one, but that's an example. Like massive companies making massive moves.

1:59Jon Quast:I feel like there were two tales of the first half too. Like the first quarter was ruled by fear. You had the Iran war starting. You had the Sasspocalypse trade. That was all during the first quarter of the year. And then the second quarter was all optimism. I mean the Iran war ended and restarted 78 times and each time the market re-rated and had some positive you know some optimism there you know we saw the AI trade really start to pick up especially when it comes to like the picks and shovels plays for the first time since 2003 small caps outperformed the S &P 500 for the first half of the year by a significant margin and I mean we saw a lot of kind of unique aspects of this year you're right it was kind of a roller coaster ride.

2:43Jon Quast:The S &P 500 is up for the year, but it was not a straight line getting there.

2:47Tyler Crowe:And something you mentioned, too, while we were pre-taping is, I think this is the first time in a while that the magnificent seven stocks were actually underperformed the S &P 500 on a total basis. So, you know, a lot of wacky Wednesday, everything is upside down sort of feeling to what we've seen so far this year. Now, like you said, a lot of the things that we've seen so far have been like solid trends. And I think people who have been listening to the show kind of caught on to like, what's done well, what's done great. You know, stuff that stinks is like SaaS companies and not doing necessarily well because, you know, death of AI.

3:21Tyler Crowe:And then AI infrastructure companies are the ones that are, we're actually killing it. You know, we're talking about the chip companies. A lot of the tangential industrial companies are associated, but there's a lot of other like hidden aspects and like maybe unconventional winners so far in the S &P 500. So guys, what did you like, When you look down the list, and we kind of scoured them a little bit before the show, which one popped out as like, hey, this is doing surprisingly well. It's not correlated with these megatrends that we're talking about here.

3:47Matt Frankel:Yeah. I mean, to your point, it's basically the AI infrastructure build out that is among the top performance in the S &P 500. But if you go down the list a ways, number 51. So this doesn't even crack the top 10%, but this is Casey's General Store. And that ticker symbol, C-A-S-Y. This is a Midwestern convenience store and gas station chain, and it was up 41 % in the first half. That's a tremendous six-month performance. Doesn't even crack the top 10 % of the S &P 500, which is just remarkably laughable to me. But with gas prices going higher, I wasn't surprised that people were spending on gas necessarily.

4:26Matt Frankel:But I was wondering, is this consumer discretionary spend going to come under pressure? will restaurant sales. I mean, they were kind of under pressure here in the first half of the year, but you look at Casey's where it really makes its money is in the prepared foods part of its business. People go to the gas station. Now you can get kind of these grocery items as well, but the prepared foods are close to a 60 % margin. So this is the real moneymaker for the business. The same store sales for prepared foods up 5 % in the first half of its fiscal 2026, which just ended here in April. But that's a very strong showing in more of like the restaurant category here for Casey's.

5:07Matt Frankel:And it is driving a lot of its outperformance right now.

5:10Jon Quast:Yeah, I think my biggest surprise, and Tyler kind of mentioned this, was that the MAG7 underperformed the S &P 500 for the first time in a while. And was how well the S &P 493 did, the other, you know, every other company in the index as a whole. I mean, there are some obvious examples of companies that are benefiting from the second wave of AI. and that's really what's driving it. You know, the big, the hyperscalers already had their benefit in the past few years. Just think companies like Micron, as Tyler mentioned earlier, and SanDisk, the memory companies are obvious examples. But then if you look at kind of picks and shovels plays that are a little below the radar, like Corning is a big surprise to me as how well it's done.

5:49Jon Quast:GLW is the ticker symbol. It's a 175-year-old company that's a specialty glass and fiber optic cable maker and companies like Corning and others are being revalued as AI infrastructure plays because they're benefiting from that massive wave of data center spending. So companies like that, I think are the biggest positive surprise to me. And there are several other examples of those.

6:11Tyler Crowe:I think we're gonna have to talk to the production team. I think we need to do like a field research road trip and we'll do like a Casey's, Bucky's, Wawa, all of the like hyper loyal customer-based convenience stores across America. That could be a fun little research topic. Like we said, these are some of the unconventional winners. And like we said, the losers, you'll find a ton of SaaS companies, things like that. A lot of tech software companies, I guess is the best way to put it. But obviously, there's some down in the loser category. Same thing, like unconventional losers. What were some of the things that you guys found that really popped off the screen there?

6:47Matt Frankel:For me, it was Tractor Supply Company. This is ticker symbol T-S-C-O. It's down 36 % in the first half of 2026. That makes it the 17th worst performer in the index. Now, the company is forecasting some kind of tepid top line growth as well as EPS growth for the year. So I'm not necessarily surprised it's underperforming the index. But I am surprised that it is down so sharply because it is still forecasting modest growth. It's not like the business is falling apart. So it's actually down 50 % from its all-time high, which is its biggest drawback in more than a decade. So that really surprises me.

7:26Matt Frankel:Personally, this is a dip I took advantage of because I think that Tractor Supply Company is just a rock solid business year in and year out. I think that its customers really do rely on it for a lot of things such as their animal feed. This is a good dividend growth company as well. 17 consecutive years of raising that dividend. And I do have a place in my portfolio for dividend growth companies. And with the yield at close to 3%, that's an all-time high for tractor supply companies. So it's one that I went ahead and added in the first half.

7:57Jon Quast:Yeah, I mean, there are some of the S &P 500 companies that perform poorly that I really wasn't surprised about. Like Intuit is at the bottom of the list. They should be worried about AI disruption fears. They make a lot of sense for this business on both the tax prep and the QuickBooks side of the business. one that really wasn't on my bingo card to fall 37 this year was FICO, our Fair Isaac company, the company behind the dominant credit scoring system. Yes, they're a SaaS company, but just the dominance, the relationships they have, I thought were more of a moat than they turned out to be. For the first time ever, we're really seeing serious competitive threats.

8:33Jon Quast:Like mortgage lenders can now use the Vantage score, which is the number one competitor for the first time ever. And there are legitimate questions about how big of a moat their proprietary scoring system is. which has been a very well-kept secret over the years, if AI's capability of evaluating consumer credit risk improved to the point where it's not really needed anymore. So that's one that surprised me.

8:55Tyler Crowe:Yeah, I feel like a lot of that will also come down to not only can AI do it, but will regulators let AI do it? So fascinating story to see how willing we're going to cede all of our underwriting to the AI. Coming up next, we're going to talk about the challenge of selling into the China market recently.

9:20Tyler Crowe:Do you have individual stocks, a 401k, or retirement accounts? Urgent warning. The United States Securities and Exchange Commission plans to eliminate quarterly reporting. This would blindfold investors from the information needed to make smart financial decisions. It would be good for corporate insiders and bad for you. Go to bettertakeaction.org to speak out before it's too late. It only takes two minutes. Join us now. BetterTakeAction.org. So on yesterday's show, we took a look at Nike's earnings. And one thing that stood out to me when I was on the show there is the sales declines in China.

9:54Tyler Crowe:And this is like a multi-year trend that's been going on. Nike's China sales are down like 30 % than they were like five years ago. And I wanted to pull on this thread some more. And you start to see this recurring theme with a lot of other companies. The top story of the Wall Street Journal this morning business section was declining market share for non-Chinese automotive companies in China. This comes on the heels of Starbucks selling a majority stake in its China operations to a local private equity firm. There's numerous consumer brand companies, especially in like the beauty and health personal care space that we've seen large retrend declines, mostly because of wheat China sales.

10:31Tyler Crowe:So there are a few of the many stories out there that where China was once a major growth engine for a company, but now it's becoming a headwind. And guys, there's a couple reasons for it, but what to you are some of the things that you're seeing that could help explain this phenomenon?

10:48Matt Frankel:Well, I think that one thing that stands out to me is that China is capable of making really high quality products now. You think about how it used to be. It used to be you bought, if you wanted to save money, you bought a Chinese product. If you wanted a quality product, you bought American. And that's no longer the case. This is a trend that economists have noted for a while, but I don't think that that has sunk in to the consciousness of the general population. It's just entrenched in our minds that China makes low quality products. But in reality, they've really upped their game. Their manufacturing capabilities are incredibly modern and incredibly tech heavy.

11:24Matt Frankel:And so it's actually able to compete on both the low quality products for just cheapness, but also your higher end quality. they do have viable alternatives to some of these American brands. And what is interesting is, because it has invested so much in the manufacturing infrastructure, it's really hard for American manufacturing to compete on price. And so China does have some advantages when it comes to that. And I think that that does make its products a little bit more of a viable alternative and does put some pressure on American companies.

11:56Jon Quast:The other side of it is their Chinese consumption has declined significantly. China went from being one of the highest growth economies that our companies can get into. Vehicle sales in China fell 20 % year over year in the first quarter. There's a lot of other cases or other industries where we're seeing declining consumption. And John's right. China's manufacturers are making higher quality products than ever before. They're innovating at a faster pace than we've seen in ever before. And the combination of those two things are making it really hard on American companies to find growth in China.

12:30Tyler Crowe:The weak domestic market forcing everyone to find markets elsewhere has been a big thing. I saw an incredible statistic where it was like, I think it was 20 something percent of sales in broader Southeast Asia of like electronics, cars and stuff like that were Chinese in 2014. And now it's like 64 percent really going to show like they're starting to dominate some of their regional markets as well. I mentioned some of the companies that have already suffered a little bit, but guys, what are some of the companies on your radar that maybe have not seen the China headwind that we've talked about with like Nike and others, but could be facing it rather sooner rather than later?

13:06Jon Quast:There's a difference between having seen the Chinese headwinds and having it priced into their stocks. So one I would want to call out is Apple. Apple is a company that has been meaningfully losing market share in China for years. I mean, the company has resorted to heavily discounting some of its products in China. And that's a practice, as we know, that Apple doesn't really do in the U.S. I mean, luxury good makers in general are another example. LVMH is a big one. They specifically cited that China's slowdown is an earning headwind. But I see Apple is the biggest not yet priced in story. Huawei, their quality of their smartphones have just grown exponentially.

13:43Jon Quast:And this could keep part of Apple's revenue base that's tied to China declining for years to come.

13:49Matt Frankel:For my part, I don't want to sound the alarm yet because I don't think that this is a problem necessarily yet. But AI memory is a huge, huge trend right now. There are companies enjoying just unprecedented profit margins because of how in demand their products are and how little supply that there is. That is a trend that I do foresee continuing for some time. However, we do need to make note of some advancements, potentially advancements, in the Chinese market. And that's from Chongqing Memory Technologies. It reportedly just reached parity with Samsung and SK Hynix with their memory products.

14:27Matt Frankel:Now, it would still need to level up just a little bit more to really start taking on the top high-bandwidth memory generation 4 products that AI really needs. But it is closing that gap. And if all of a sudden a Chinese technology company could release a memory product that is on par, it might be able to siphon off some of the market share, at least in the international markets, which would disrupt the supply and demand imbalance in the memory market.

14:53Tyler Crowe:Guys, I want to test out like a working investment thesis. It's not on a particular company. It's a little bit more of a theme. The companies we've mentioned, Nike, Apple, some of the memory companies, a lot of these companies benefited in the international growth phase immensely. You know, from, I would say like, starting with like NAFTA in 1990, all the way up until 2016, 2017 was this long tail growth of globalization, entering the Chinese market, entering global markets. And a lot of these companies became dominant players in the international markets like China. And I'm starting to think that now that these mature companies, the ones that have, you know, gotten to the point, it's like we need to win internationally, especially in China and Southeast Asia to grow our businesses further, I feel like those are weaker ones.

15:44Tyler Crowe:And companies that not have yet reached the, we need to start winning internationally to grow. We still have a lot of room domestically. I feel companies in that phase are likely better investments today because the international markets are just far more competitive than what they used to be. So that's my working thesis here. What do you guys agree? Disagree? Where should I tweak this?

16:06Jon Quast:I think directionally, you're right. Many international markets, especially China, have become far more competitive over the past decade or so. And it's big. I mean, consumption's declined. You're competing for a share of a smaller market with companies that are doing it better. I mean, companies like Starbucks, like Nike, like the automakers used to use that easy growth from international expansion playbook. And you simply can't do that anymore. And I mean, when you look at the top 10, 20 performers of the S &P 500 so far this year, they're almost all U.S.-driven businesses that get most of their revenue domestically.

16:37Jon Quast:But that's not to say that international is never going to be a big growth driver again. So I would refine that thesis to say the best move isn't to avoid companies that are pursuing international exposure. It's to favor companies that have more of a focused international strategy built on mastering a certain market or a certain technology in a certain market that have really of focus.

16:58Matt Frankel:Yeah, Tyler, I would disagree with you slightly. It's really hard for me to imagine a company that, especially a technology company that does well over the long term, that doesn't compete well internationally. Maybe there's a case for like a retail chain in the U.S. or a restaurant chain that, you know, it doesn't need international to provide good shareholder returns. But a lot of these companies, if they are going to be some of these life-changing investments, the ones that we want to own, chances are they're going to have to go to the international markets for growth, and they're just going to have to win in spite of the competition.

17:31Matt Frankel:And, you know, I halfway wonder with some of these companies that are doing poorly in China, it used to be an easier game. I'll concede that point to you. And I wonder if some of these early movers in China just didn't get lazy with how easy it was to just bolt on China operations and then start getting incremental revenue. And now all of a sudden it's harder and they were caught with asleep at the wheel because some companies are doing well still in China. And one that I'd like to point out is Decker Outdoor. This is ticker symbol D-E-C-K. This is a parent company of shoe brands, Hoka and Ugg.

18:05Matt Frankel:It's really still growing sales in China. It's selling them for full price. So it's maintaining those strong profit margins. And management says there's only 30 % brand awareness yet in China. So there's potentially still room for ongoing growth in China. So I think that some companies are competing well, and I think that those deserve some attention.

18:23Tyler Crowe:Slight shout out to Hoka because I just got my new Speedgoat 7s and I got to say that is a fantastic product. They're not even paying me to say that. Free advertisement. There you go, Deckers. Coming up after the break, we're going to hit the mailbag.

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