Where's Jack Ma?

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Get the facts at meta.me/risk. On the positive side, you have these phenomenally innovative companies. China has these tech firms that are not copycat firms. They are not copies of US equivalents, even though they're compared to them. They are truly innovative, spectacular firms. On the other hand, you have to always remember that you're investing into a country without rule of law. And what that means is if the company does something that the party doesn't like, The company may disappear, or it may be restructured, or its CEO may disappear.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's Leland Miller. He's the CEO of a research group called China Beige Book. It's known for its unvarnished, up-to-date analysis of that country's financial conditions. We have a lot to ask Leland about. How's the Chinese economy? What's next for trade tensions between the US and China? Is it safe to invest in Chinese stocks? And where in the heck is Alibaba founder Jack Ma? Ahead, we'll also hear from Morgan Stanley's chief US stock strategist, Mike Wilson. He says inflation's coming and sooner than you think, and that investors should prepare. Listening in is our audio producer Meta. Hi, Meta. Hi, Jack. You might have noticed, Meta, that America's Capitol building was stormed by a mob this past week, forcing lawmakers to flee. Did you see anything on that? I did, yeah. Yeah. Now, just out of curiosity, as you watch that on TV, were you thinking to yourself like, wow, I've come to live and work in the United States during an interesting time? I did, yeah. Yeah. I just want to tell you, I'm going to say the same thing I used to say before the pandemic when my family would have guests over for dinner and one of my children would, let's say, burp or swear or burp and then swear at the table. I would say, we're not usually like this, okay? We're decent people. I'm pretty sure we're decent people. I want you to know that, Meta. Well, I'm happy to burp or swear right now if that makes you feel better about the situation. I think it would make us all feel better, yes.

Maybe a little later.

All right. Well, the stock market didn't seem too bothered by the mayhem. And I've been thinking, of course, about what differences investors should expect this year from last year. And earlier this week, I reached out to someone who expects quite a few differences. Hi, it's Jack Howe at Barron's.

Hey, Jack, how you doing?

I'm all right. I need you to explain to me everything that's going to happen in financial markets in 2021. And please frame your answers as absolute certainty, because we all really need to know.

Okay, um, this will take about 3 minutes. You got 3 minutes?

That's Mike Wilson. He's the chief U.S. stock strategist at Morgan Stanley, and he says inflation and higher interest rates are likely to be the next big surprise for investors, and then it could happen quickly without warning, that it's the biggest risk and opportunity in 2021. Now, inflation is a broad rise in the price of goods and services. I've heard some increased talk about inflation recently, but Mike says investors might not be taking the possibility of faster inflation seriously enough.

While people do acknowledge that we could see, you know, some acute price inflation in certain items when the economy, you know, reopens, like for example, maybe air travel, you know, air tickets or restaurant prices or whatever, you can pick your favorite thing. Most people seem to think that it's going to be transient or temporary. And that's part of the reason why the bond market is not challenging the Fed with trying to press higher on long-term interest rates.

Let me explain that last part about the Fed and the bond market. Meta, do you have any monetary policy music? I'll find something. Hang on. So the Federal Reserve exerts direct control over short-term interest rates. It lowers them when it wants to spur economic activity, and it raises them to cool the economy only when inflation heats up. For more than a decade, inflation has been exceptionally low and economic growth has been ho-hum, so the Fed has generally kept short-term rates very low, near zero. Longer-term rates Treasury bond yields, for example, sometimes follow short-term rates higher and lower, but not always. And sometimes the Fed manipulates these long-term rates indirectly by buying and selling huge quantities of bonds. Bond yields are important determinants of things like mortgage rates, but they also affect the stock market. When bond yields are low, stocks look attractive by comparison. So where are we now? Well, short-term rates are near zero. And the 10-year Treasury yield is quite low too, about 1%. Stock valuations look a little high. When Mike says that the bond market isn't challenging the Fed, he means that the Fed has committed to keeping short-term rates low for years, and it can only do that if there's little inflation. If bond investors thought that the Fed's wrong, and we're headed for a sharp rise in inflation, they dump bonds, which would cause bond prices to fall, which mathematically would cause bond yields to rise. But that's not really happening. Mike thinks it might soon. He thinks 10-year Treasury yields could double or more.

Every other asset class in the world, whether it's commodities or equities or certain styles of equities in particular, relative ratios, And, you know, by the way, our forecast on global GDP, what we think is gonna happen to inflation over the next 6 to 12— I mean, all those things are pointing to much, much higher interest rates.

Mike says that one thing that could increase inflation, thereby causing bond yields to rise, is high government spending. But hang on, we had plenty of deficit spending during the global financial crisis just over a decade ago, People said back then that inflation would get out of control, but inflation barely budged. So why would government spending cause inflation now? Mike says that wealth and income inequality have been a growing problem for decades.

There are two economic realities in the U.S. right now.

The Great Recession was devastating for working people around the world. There's still trying to recover from that. But at the same time, the growth of tax havens has allowed rich people and corporations to avoid taxes or to minimize taxes. So the combination of those two things is what is producing this great income inequality. New Federal Reserve data just released shows that just 59 Americans own more wealth than the poorest half of the country. Past efforts to stimulate the economy by buying bonds to bring down rates, for example, largely benefited the wealthy because they caused stock prices to rise. And when the wealthy get more money, they tend to save it. That might push the prices of investment assets higher, but it doesn't generate much inflation for ordinary goods and services. The divide between rich and poor is now so glaring that current stimulus efforts and likely future ones will be more targeted to lower-income groups. They're more likely to spend extra money they receive, which is good for the economy, but which also might contribute more to inflation. Here's Mike.

We've seen certain parts of the community who've been affected more directly by the pandemic because— why? Well, because they live in tight quarters. They don't have a second home that they can run to. Okay, and hide out. Okay, they have to engage in, in blue-collar type jobs, essential workers. So of course they're going to get exposed more, right? So just another kind of kick in the teeth for the low end of the spectrum, you know, and they're demanding more this time and they're getting it.

So when will we see more inflation and higher yields? Mike says soon.

We're going to see, you know, some of these inflationary pressures build in certain things. Maybe it's in travel, maybe it's in restaurants, maybe it's in other items, maybe it's in Who knows, right? But people start doing more normal activities. And you could see this happen really quickly. And I think it could be in the first quarter where we wake up and all of a sudden, 10-year yields are at 1.50. That's not our official forecast, but that would not surprise me. Markets have a way of moving, as I said before, in a nonlinear way, much faster than you might expect. And the adjustment process is quite quick.

The good news is that Mike thinks higher inflation won't necessarily derail the rising stock market. But he thinks there'll be a change in which kinds of stocks lead the market. In fact, he says that's already happened.

If you actually look at what led from the March lows, which is the proper way to look at it, like what's been the leadership groups and sectors in this new bull market, it's very clear. It's small caps, it's cyclical stocks like materials, it's some of these energy stocks that are up 300%, 400%, 500%. It's cyclical stocks in the industrial world. It's not these, you know, big-cap growth stocks. That's not what's been leading since March and definitely not since September.

I asked Mike about the dramatic run-up we've seen in stocks like Tesla and whether that's a sign of a bubble. Mike doesn't give opinions on individual stocks, but he says broadly speaking, we're not in a bubble, although some of the most speculative stocks might be.

I think that the average stock is not in a bubble. At all. In fact, there are many sectors, whether it be financials or materials or energy, some of these other areas have really lagged for a decade. I mean, they're cheap, but there are pockets of excess that absolutely are going to not only underperform, but they're probably going to lose money on. And so those are the areas that I think investors need to be careful with in these really speculative parts of the market where valuations have just gotten out of sight.

Maddie, how long are you gonna keep us waiting for that burping and swearing you were talking about? I think I'm having second thoughts on that. Drink something carbonated and think it over. I understand that we've been getting some questions from listeners about China. Yeah, we have. Here's one from Kevin who— well, actually, we don't know where he lives. Okay. I'm going to assume Sheboygan, Wisconsin. Let's hear it.

Hi, Jack. Really enjoy your column and this podcast. My question is, I'm interested in investing in Alibaba and Taiwan Semiconductor. My hesitation comes from the uncertainty with the government of China. Am I taking on a lot of risk in doing so, or do I not need to really worry about that? Thanks for the great show.

Thank you, Kevin. And Meta, we had one a while back from Mike. He works in Silicon Valley. Can we hear a bit of that one too? For sure. I guess my broad question will be, where do you see the China-US relationship going in relation to the stock market, in relation to sanctions, in relation to individual companies that are now being impacted by the Chinese government canceling orders? Is it going to be something that plays out for a long time? How will this affect the normal workers? Is this the new version of the Cold War? Appreciate your responses. Thanks. Thank you, Mike. Now, I'm not a China expert, but lucky for me and Kevin and Mike, I know a China expert. Hi, Leon. It's Jack Howe from Barron's.

Jack, how are you?

Doing great. Thanks for making a few minutes to speak with us.

My pleasure.

Leland Miller is the CEO of something called China Beige Book. It provides economic data for China. Now, we already have something that provides economic data for China. It's the Chinese government, but there's a problem with its data. Here's Leland.

Well, it's become very clear over time that China releases economic data that, that tell the political story it wants to tell. So for years and years and years, there's been high growth rates. Now things are slowing down, and China wants to be able to tell the, the most sanitized version of what's going on. They like to talk about stability. They don't like to talk about weakness. And so what you have coming out of the government is always a very sanitized version of data, economic narratives, etc.

There's another problem with official Chinese economic data. There's not enough of it. Back when Leland was a corporate attorney advising hedge funds on China, he noticed they weren't asking the right questions because they had limited data to ask about. So he began developing his own data service by surveying a mix of firms that he says represent what the economy looks like. There are private and state firms, large and small, coastal and rural, domestic and multinational. How does the Chinese government feel about the service Leland provides? It doesn't love it.

They don't love what we're doing. There's no question about that. I think about 80% of the time, 90% of the time maybe, they're pretty annoyed at having people come out and very publicly say, look, Chinese economic data is manipulated. The narratives are false. This constant stability is a facade. You know, you've got real dynamics here that they're not acknowledging. Of course, they don't want to hear that.

If the Chinese government is annoyed 90% of the time, what about the other 10%?

The government has seen that while we are very critical of their take, often, most times, that during times of significant stress, we're not China bears. We're not in there to see the economy collapse. We were actually much more bullish than anybody on the street during times where there's been significant volatility and significant stress in the economic system. So I think that's given us credibility that we don't have any mission here except to get it We're not bulls, we're not bears, we're just calling balls and strikes on the data.

So what does Leland's data say now about the Chinese economy? He says China's recovering, but it's not an especially intense recovery, and it's being driven more by increased production than by strong demand from households.

Even if it's enough to sort of pull China out of the morass going into 2021, it's certainly not a strong enough recovery to be able to pull the global economy out of its rut. And that's the real question for 2021. Will levels in China be sufficient to lend a hand to the rest of the world? And right now the answer is no.

I wanted to ask about Alibaba, China's big online shopping and payments company. But first, where the heck is Jack Ma?

He is very powerful, very wealthy, and generally a very public figure, but Since giving this speech that was critical of China's government, Jack Ma hasn't been seen in public. And now many are questioning, where is Jack Ma?

Jack Ma is the founder of Alibaba and a bit of a showman. 3 years ago, he appeared on stage at a company party dressed like Michael Jackson and wearing a gold mask while revving a motorcycle. Then he got off the motorcycle and started dancing. I give his moves a 4.5 out of 10. The pelvic thrusting wasn't quite as pronounced as it should be for a man worth more than $40 billion, the largest fortune in China. Chinese regulators recently said they're launching an antitrust investigation aimed at Alibaba And now Jack Ma hasn't been seen in weeks.

Alibaba is probably the most fascinating single Chinese company. Jack Ma has been out in front of cameras really antagonizing government regulators for, for a number of months now. I think a lot of people think that's the reason he's disappeared and that Alibaba is under such duress.

Back in October, Jack Ma said at a tech conference that Chinese regulators stifle innovation. He compared China's big state banks to pawn shops. One theory is that Ma has gotten, in the view of China's ruling Communist Party, too big for his britches, and the government wanted to take him down a notch. But Leland says that's not the whole story. He says Alibaba has evolved into the most important company in China's financial system, and that money has been leaving state banks to go to Alibaba's platform.

All this money would sort of come screaming out of the state system into this private, much more lightly regulated system, and it drove the state bankers crazy. They had to adhere to all these very tight rules, and here was Jack Ma making a fortune, stealing their deposits, not having to do anything. So over the course of many years, this has built up considerable antagonism, and I think what's happening right now is, yes, a result of Jack Ma getting too publicly loud, pushing back against the government, but it's also been building up within the Chinese system for many, many years.

Okay, so where's Ma? Best case for him, he's keeping his head down, but Leland sees other possibilities too.

He may have been grabbed by the party and he may be in a dark room right now. We just don't know. And, you know, this may be something where he's going to come out more repentant a few, you know, weeks or months from now, or it may be something in which he comes out a few weeks or months from now and we hear that Alibaba has been restructured and that parts of Alibaba no longer look like Alibaba or no longer owned by Jack Ma that are are now property of the government. So we really don't know what's happening. We do know that Jack's in a lot of trouble, both personally and in terms of his company.

And that sums up some of the strong positives and strong negatives of investing in Chinese stocks. Here's Leland.

On the positive side, you have these phenomenally innovative companies. China has these tech firms that are not copycat firms. They are not copies of US equivalents, even though they're compared to them. They are truly innovative, spectacular firms with spectacular spectacular upsides in a vacuum. So there's these great investment opportunities because they're great firms. On the other hand, you have to always remember that you're investing into a country without rule of law. And what that means is if the company does something that the party doesn't like, the company may disappear or it may be restructured or its CEO may disappear. You never know on this stuff.

There are also other more technical issues related to buying Chinese stocks like Alibaba the trade in the U.S.?

You know, when you're talking about Alibaba and a lot of other Chinese companies, you also have the problem where a lot of the quote-unquote equity owned by investors is not actually into Alibaba or the Chinese company in question. It's equity in an offshore vehicle, which then invests in the company. And there's nothing to say that, you know, the Chinese government couldn't just sever that link and leave investors hanging out to dry.

So investors should be aware of the risks. Now, what about the trade tensions we've seen in recent years between the US and China. Have they peaked? Leland says trade tensions could get significantly worse.

I think that the path of this relationship is somewhat set in stone, at least for the short and the medium term. The two sides view each other as competitors and oftentimes as adversaries. And I think there's a recognition on both sides of the aisle in Congress, both sides of the political divide across the United States, that China has been eating our lunch for a while. Now, is that true? Only in some ways. A lot of it's totally overhyped. I don't think that any president, no matter who it is, or any congressional majority will ever have the ability to push a much softer China policy or a much more open China policy right now, simply because of the political sentiment behind it.

Leland doesn't invest in China, but he says that's to avoid conflicts of interest. He says there are big opportunities in China, but investing there isn't for everyone.

There are plenty of ways that people are going to make money in China. There's plenty of great companies, there are plenty of great opportunities, but the vast majority of people we see going into China, whether it's companies, whether it's hedge funds, get absolutely destroyed because they don't take seriously how different the system is, how different the financial system is, and how different the politics are than just about anywhere else they're investing in.

Thank you, Kevin and Mike, for sending in your questions. Hang on, let me just rev this motorcycle real quick and then hop off and show Jack Ma how it's done. Meta, my dance music please. Everyone, please keep the questions coming. Just tape on your phone, send a recording in an email to jack.hou— that's H-O-U-G-H— at barons.com. Starting to feel that in the glutes now. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, write us a review. That's a cramp. Metta got a cramp. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @JackHough. H-O-U-G-H. See you next week.

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