Microchips, Chinese Real Estate “Rot,” and a Global Economic Forecast

Dave:
Hey everyone. Welcome to On The Market. This is your host, Dave Meyer, and we have a very fun show for you today. We’ve heard feedback from our audience that you all have enjoyed some of our forays into different parts of investing and different parts of the economy beyond just real estate investing. Over the last couple of years, we’ve had some shows about the stock market or about crypto, or just about different economies like in Europe or in Asia. And today we’re going to be exploring the global economy and where it sits at the end of 2023.
To help us in this exploration, we are bringing on Bill Mann from the Motley Fool. He is the director of small-cap research there, but he’s also just someone who knows a lot about the global economy from his job at the Motley Fool, and he’s also very fun to talk to. So if you have been enjoying the kinds of shows that we’ve been doing where you get to learn more about how to think holistically as an investor, how many of these different disparate parts of the economy, what’s going on in different parts of the world will actually truly impact your business, this show’s going to be a great one for you. With that, let’s bring on Bill Mann from Motley Fool.
Bill Mann, welcome to On The Market. Thanks for being here.

Bill:
Hey Dave, how you doing?

Dave:
I’m doing great and I’m very excited to be talking to you. For everyone who doesn’t know you from your work at The Motley Fool, can you tell us just a little bit about yourself and your work?

Bill:
So I am the director of small-cap research here. I also have our international brief at the company. The Motley Fool is almost entirely equity-based. We look for companies all around the world and we have a very specific style. We are long-term buy and hold investors. We believe that people are best suited doing the work and making decisions for themselves. And so from my own standpoint, I view every day for me as being like a treasure hunt. I come in and I look at parts of the market where a lot of people don’t really spend a whole lot of time.

Dave:
And are you finding a lot of treasures right now?

Bill:
The answer is yes, but they’ve been laying around for a long time. I would describe the current market environment as being one in which in the US we have an S&P 7 and then an S&P 493, and then everything else below that. And it’s almost like they’re unrelated from each other at the moment. So there are a lot of treasures. And Dave, as you know, the difficulty in the market is that just because you found a treasure, it’s not like somebody’s going to come by instantly and say, “Oh, that’s a treasure.” I mean, it could look like junk to everybody else for a long period of time. So you have to be a patient treasure hunter, and hold onto your treasure as long as you can.

Dave:
Well, I think that our audience is mostly real estate investors. I think that is a very apt analogy also for our industry too. Being patient is investing, the name of the game, it’s a great way to proceed. So glad we sort of agree there on general philosophy.

Bill:
Yeah, I still kick myself. In 1993, I looked at a place to buy in an area of Washington DC called Logan Circle, which I don’t know a lot of your real estate investors now, when I say the words Logan Circle will go because it’s literally the nicest part of Washington DC now, and at that time it wasn’t, but you needed to be willing to bend your headlights around corners and see what was coming. So yes, I am glad to be talking to people who understand this principle internally.

Dave:
Yeah, people did not know Logan Circle was a treasure for a few years, not in 1993, and maybe not for a little while, but they got there, eventually. All right, so most of our audience is real estate investors, and we might delve into sort of equities a little bit here, but you are also a student of the global economy. And so I was curious to just get your high level view of the global economy right now and where you think we are in this very unique moment.

Bill:
Economies are systems, and maybe that’s not a really brilliant insight, but we have just gone through a period of time in which in 2020 we had $19 trillion of sovereign debt that the debt holders were paying for the right to hold. They were negative yielding interest rates, which is a kind of thing that for the entire history of the financial markets, people thought of that as being like the Yeti. There’s no such thing as negative yielding interest rates. So obviously one of the reasons why that sort of thing would exist is that inflation was the thing that the central banks were trying to bring about. Inflation is something that comes along with the economic activity. It comes along with growth. Anything that they could do to keep us from entering a deflationary environment, they did. So we’ve gone in a very short period of time, as short as we can ever remember of going from a low interest rate environment to I guess what you would maybe feel like a high interest rate environment, but it’s somewhere in the middle.
And all of these systems really, really struggle when you go through that period of change. You get to stasis on the other side and it’s fine, but it’s hard to guess. It really is, where are interest rates going to end up? We don’t really know. But globally, what we’re seeing right now is that the US has been raising faster than everybody else, and commodity prices have been going up. You can see it in a dollar basis, but you can imagine in a market in which the dollar has increased against your local currency, and oil prices have gone up, just how destabilizing that can be. This doesn’t maybe count for the countries that produce oil, but for everybody else, I mean it’s a really big deal. So I would describe the global markets right now as being unsettled and looking for a new equilibrium, which they will find, but it’s tough to predict when. And I think interest rates and currencies have a lot to do with that.

Dave:
Yeah, uncertainty is the only honest way to assess the situation right now. It also seems that different countries and different regions are experiencing really different environments. In the US obviously as you said, inflation was the thing. Same with things in Europe, a lot of South America, same thing. But then you look at an economy like China that’s now experiencing deflation. So how do you sort of square this on a global sense where there’s sort of different areas of the world that seemed so different when just a few years ago, it seemed like the global economy obviously has its own little sectors and caveats, but was sort of moving in the same general direction.

Bill:
Yeah, we’ve really gone through a period of time in which, and it started in the middle of last decade, and it really started with China’s Belt and Road initiative where you began to see some of the larger countries using economics as a form of warfare. You’ve seen it with Russia in regards to both our isolation of Russia, but then also Russia using gas prices as a weapon in Europe. So I think one of the things that is really happening is that we have gone from being a system that has favored globalization to one where you start to see that fracture a little bit. I think the US economy and the Chinese economy still are very deeply linked, but they’re much less so than they were even just prior to the pandemic.
And so when you see, again, to get back to what I was saying before, a dislocation or a change, then you’re going to see each individual part of that system move in its own way. In the case of China, it has essentially grown over the last decade doing a bunch of capital projects, a huge amount of construction. They build roads to nowhere, they build airports. These types of things are a form of growth, but if they don’t end up being used, then they can become deflationary, because you don’t need it, and you don’t need to build another one. That is an interesting thing about infrastructure investments is that once the infrastructure’s in place, there’s no need to repeat it.

Dave:
Yeah, if it works.

Bill:
Hey, let’s put in a third airport. You don’t need that sort of thing. So what you’re seeing in China now is an echo of what has probably been fairly poorly conceived capital projects that have brought about growth, but not all growth is the same because the consumption hasn’t been there.

Dave:
And how concerned are you about this, both from a equity standpoint and just from a global economy standpoint? It seems that at least in my lifetime or adult lifetime, all we hear out of China is outsized growth, and we’ve never really seen a period where China is, it’s now a period where the China is standing as the second-largest economy in the world goes into a recession or goes into a deflationary environment. We’ve never seen it. So what do you think might come of this?

Bill:
I think one of the most important things for people to realize is that there is a bit of a decoupling from China, but to your point, we talk about, for example, some of the China geopolitical risks, but we don’t talk about the things like for example, that 94% of Apple’s production is in China, and 25% of its revenues come from China. What happens to Apple, which is a huge component of the US stock market, if China continues to stumble? And I think it is absolutely the case that China is stumbling and will continue to do so.
Apple can’t simply snap their fingers and move everything to India. I mean, they absolutely positively can’t do it. First of all, the Chinese would notice, they’re like, “What are you doing?” “Oh, no, nothing, nothing, we’re fine.” It doesn’t really work that way. So we are still deeply, deeply linked to China. The Goldilocks scenario is actually fairly negative, but it’s not terrible. We kind of bumble along and China continues to be a manufacturing growth engine. There is some decoupling from China and the poor capital investments that have been made over the last decade start to get absorbed. The really bad ones would be if China’s unemployment rate continues to skyrocket, and amongst people below 25, it’s believed that it’s as high as 45%.

Dave:
But we won’t know.

Bill:
But we won’t know.

Dave:
Because they stopped releasing that data.

Bill:
Exactly, exactly. Well, and even before they stopped releasing it, those numbers were, I don’t know how to say it, un-pejoratively, they were not necessarily the ones that you would put your full faith into that are being correct.

Dave:
Fair enough.

Bill:
So ultimately, if China does go into a deflationary spiral, because our countries are so highly linked, I think that there is the potential for some real pain in the US, but even worse in places like Japan and Australia.

Dave:
Yeah, absolutely. That does seem to be the case. And in the real estate industry, I’m just looking at it sort of as the financial sector that we see that China’s central government is pushing their banks to sort of support the real estate industry, which might be by issuing riskier loans. And maybe that’s just kicking the can down the line. And of course, like you said, there is some decoupling, but the global financial system is strongly linked. And I worry a little bit, I’m not staying up at night thinking about this, but you read about this stuff and you do think, okay, if the Chinese market continues to collapse, it could lead to some tighter credit conditions here in the United States. And that’s just one small example.

Bill:
Dave, I think that’s exactly right. And the faith that I always put into the system is that it is somewhat self-healing, but it is not a new thing that the central government of China, the communist party of China, is using the banking system to further its political interests. That’s something that has existed forever.

Dave:
That’s a good point because it’s not like if there is this big downturn in China that it’s not foreseen, I think a lot of banks and companies that are operating in China know that this is going on and the property crisis has been going on for a year or two already. This is not a quick moving thing. So at least as an economy and individual companies do have some time to adapt to it.

Bill:
And this is where you get into the topics of the phantom cities, the ghost developments all around China. A lot of people don’t really realize, they think of China as having a huge amount of US treasuries. That is a weapon that they have over us, but that’s only one part of the balance sheet. They also have an incredible amount of debt. It may be the most indebted large economy in the world, which seems amazing in a world in which the United States and Japan exists. But it certainly may be the case. The way that China’s provinces have raised money to operate themselves is through land sales. They go to their own land banks and they sell into these property developers who then develop, and the loans come from the banks. It’s all mandated by the central authority. And again, this gets back to something that I was talking about earlier when we were talking about infrastructure. I guess you would consider housing to be infrastructure also, but even in a totalitarian society, it’s hard to sell the same land twice.
Once you have sold it, I mean, I guess you could take it back, but at some point the buyers are going to figure out what the game is. So they are selling ever more adversely selected land in a period of time in which the land that has been sold before has not generated a great capital return. And so the rot that’s in China right now on every level is substantial. So when you say the central government is getting involved in mandating the banks to do these sorts of things, to support these property developers, they’re literally just trying to plug holes in the bottom of the barrel of the whole Chinese economy.

Dave:
Yeah. That’s not what you want. That doesn’t spell confidence to me.

Bill:
What a way to break it down. Yes, that’s not what you want.

Dave:
Just, listener, if you were curious, not ideal situation. Well, so I want to switch gears a little bit from real estate to something that I think is a little bit more, I mean, obviously real estate, there are equities and REITs and stuff, but I want to talk a little bit about chip manufacturing and semiconductors, because this is something that is related to China, the whole global economy, and is closely connected to one of the, what did you call it, the S&P 7 before.

Bill:
Yeah, that’s right.

Dave:
I assume Nvidia is one of those seven that you were citing.

Bill:
It is, they did it, yeah.

Dave:
Okay. They made it to the seven. Well, maybe you could just start by giving us sort of a background on the situation with chip manufacturing and sort of how it is distributed across the globe and why it’s so important.

Bill:
Yeah, so obviously the majority of the advanced microchips in the world are produced in Taiwan, and they’re almost all produced by a company called Taiwan Semiconductor. So whenever you talk about the geopolitical situation in Taiwan, and obviously it predates the existence of Taiwan Semiconductor, but Taiwan Semiconductor is absolutely now the prize of Taiwan. The company has such a linchpin on the global economy that they’re really, if you even ask experts, there really isn’t a good answer where the second option were to be. If you snapped your fingers and Taiwan Semiconductor disappeared, there’s nobody to step in. They are so far ahead of any other comparable producer.

Dave:
And why?

Bill:
They would say that it has to do with the process and the type of talent that they have in Taiwan. And I think that this is probably somewhat true, that they have 3,000 of some of the best developers in the world all in one space. They have been incredibly paranoid about technology transfer, making sure that their trade secrets don’t get out. You can be fired in Taiwan Semiconductor for doing something like changing the heading on an email that you’ve been forwarded. The level, it seems nuts. I mean, I’ve done worse things than that. I don’t know about you, and I haven’t been fired.

Dave:
I’ve done worse things today, for sure.

Bill:
Exactly, exactly. We had lunch here and I had seconds.

Dave:
If that is a fireable offense, I wouldn’t have made it past my first week.

Bill:
Exactly. So it is a potentially catastrophic situation. So I mean, the US has recognized this, and a couple of years ago we began to, the US government passed a bill called the Chips and Science Act, which has helped essentially fund Taiwan Semiconductor’s development of additional facilities like in Arizona. That’s the huge one. That’s being done, not necessarily at the total choice of Taiwan Semi. It’s also being done, funded, almost 70% of it is being funded by the US government.

Dave:
So that is something I was curious about because Taiwan Semiconductor company has this monopoly essentially on the most advanced types of chips. Why would they expand to the US? Is it because the US government and the Taiwanese government are also sort of intertwined and the US provides a lot of aid to Taiwan and is sort of seen as this military backstop against any sort of Chinese incursion? Is all of that playing into these little, I mean, not little, but these seemingly innocuous semiconductor plants that are going into the us?

Bill:
Well, you’ve heard of money, right?

Dave:
A few times. Yeah, I don’t have a lot of it, but I would like to have more of it.

Bill:
You don’t have Taiwan Semiconductor money, but a lot of it has to do with the fact that the US government almost, because when the US went in and said, “Okay, we don’t want these companies to sell into China anymore.” Taiwan Semi cutoff sales to Huawei, which was its second-largest customer. Huawei is one of the largest Chinese companies.

Dave:
Really?

Bill:
Yeah, just shut it off.

Dave:
I didn’t know that.

Bill:
They didn’t really have any choice.

Dave:
Because the US government insisted, basically?

Bill:
Yeah. Yes, exactly. So what’s the give back there? Okay, look, we understand that this is a painful thing for you, one of the most important companies in the world. So how about we find ways to help you de-risk a little bit. And oh, hey, by the way, we’ve got this land in Arizona. If you would like to build there, we will provide all of the infrastructure, we’ll provide a lot of the funding, and we’re just talking about manufacturing. You can retain all of your development. You can retain all of your, can retain everything that you want in Taiwan. Because by the way, Taiwan Semiconductor, like a lot of chip companies and memory companies, a lot of their manufacturing was in China. It’s not in Taiwan now. So some of the choices that they were having to make, they were forced to make at the behest of the US government and other Western powers. There is a little bit of a give back there. And so I think that that has a whole lot to do with it. That and the money thing.

Dave:
That small money thing. So when you look at the stock market, and obviously TSM is a, is it TSCM? Sorry, I can never get the acronym.

Bill:
TSMC.

Dave:
TSMC. Yeah, there we go. Thank you. They are obviously a publicly traded company, but you look at other chip companies that have been going crazy in terms of valuation over this year. Is this largely, and due to the same thing, they’re still just a chip shortage, demand is out of control, or is something else going on here?

Bill:
At least partially so. One of the largest chip companies in the world is Micron Technologies, and they just reported earnings, and they’ve actually seen a real softening in terms of pricing. I mean, in a lot of ways you have to separate Taiwan Semi from most of the other chip companies because they are commodities, right? Ultimately, chip production is in some ways no different from oil production. You basically don’t get to name your own price. The price is set for you.

Dave:
And the distinction is that Taiwan Semiconductor has the more advanced chips, right? Is that the difference?

Bill:
Exactly. They have chips that are, generally speaking, the rule of thumb is that they are two years ahead of their next competitor.

Dave:
Wow.

Bill:
I know. Which especially in technology seems like that’s literally forever.

Dave:
That’s insane. Yeah.

Bill:
It feels like we were still using digital watches two years ago.

Dave:
God, I mean now that really just underscores the importance. Can you imagine having to go back to an iPhone 11? It would be unbearable. It would be absolutely horrible.

Bill:
The horror. Yeah. So you get it. That’s ultimately it.

Dave:
Yeah, I got it. This is what’s at stake here.

Bill:
Yeah, exactly. Exactly. If we were just being released excited about the iPhone 11, so that’s really what it comes down to. I mean, it is potentially a massive, massive deal.

Dave:
So one company that I am particularly interested in, because I live in the Netherlands, I don’t know if you know that Bill, and there is a company here called ASML, which is they make the machines that make the chips, right?

Bill:
Right.

Dave:
Is that correct?

Bill:
Yes.

Dave:
So how do they fit into this whole global competition for chips?

Bill:
So we have now touched upon maybe the two most important companies in the world that nobody’s ever heard of. I mean, ASML is another one of those technology companies that the technology that they build is so sensitive that the US government, the Dutch government, the British government, they have no interest in having that technology in that knowhow end up in China or in Russia to some degree. But really China is the country that knows what to do with that type of technology. ASML is the manufacturer of the equipment that makes the highest and chips. So we always think of things as being the SNAP test. Like if a company disappeared, you did that Thanos thing and snapped your finger, and the company disappeared instantly. Things would get much, much worse if Taiwan semiconductor disappeared. But things would get gradually much, much, much worse if ASML disappeared because ASML is absolutely crucial to manufacturing for Taiwan Semiconductor amongst many others.

Dave:
So do you see, I get that. I think ASML is one of those backlogs of product orders that they could stop taking orders now and they’d be busy for the next 30 years. Like Boeing, they have these orders for decades. Do you see more manufacturing coming into the United States? This obviously matters for just the economy in general, but as real estate investors, the places where these plants go tend to be economic hotspots after they go in. Just curious your outlook.

Bill:
I think ASML, it’s a really good question. It seems to me, and this is somewhat theorizing, so if this turns out to be a thousand percent wrong, we can blame it on just a bad theory.

Dave:
We’ll cut it.

Bill:
ASML, years later, just cut it out.

Dave:
Yeah, years later, we’ll edit it.

Bill:
ASML is one of those companies that is, it’s so sensitive that I think it’s pretty much comfortable for all of the actors for it to be in a centralized place. I don’t really foresee too much of ASML’s manufacturing capacity moving away from the Netherlands, moving away from its central place. And there are other companies that are like that. FANUC in Japan, which is a robot maker, is one where they make basically everything in a single facility. And it is for those industrial espionage and technology transfer limitation reasons that they do it. So I’m not sure that ASML is going to be of a great benefit for real estate investors anywhere other than in the Netherlands now.

Dave:
For sure. Yeah, yeah. I guess my question is more like, because ASML is so backlogged, is it realistic that producers who need the ASML machines are going to be able to build new plants in the US? Whether it’s Taiwan Semiconductor or any other chip maker?

Bill:
So I never really thought about it that way.

Dave:
Well, it may just be a stupid question.

Bill:
No, it’s not a stupid question. It’s actually a fantastic one, which is, ultimately, when you think about a company like ASML, what you’re talking about is not so much a backlog. It’s a backlog at the very, very top end. So it doesn’t really slow down a Taiwan Semiconductor for ASML to have a backlog. What it does is it limits their capacity to bring out the next and the next technologies. So yes, that backlog is not ideal. It’s possible that they will solve it through an addition of ASML capacity. Most likely the way that that plays out is that it simply changes the curve on new technology adoption.

Dave:
Okay, great. Well, we started in China, we went to microchips. We talked a little bit about my home here in the Netherlands. I’d love to just hear your thoughts on Europe in general because we have Germany, which is the biggest driver of economic growth traditionally in the EU, technically in a recession right now. And we’re seeing the continent, some economies doing well, some doing poorly, and as obviously a big integrated part of the global economy, give us an assessment of the Eurozone.

Bill:
So I would describe the US dollar right now as being a bit of a wrecking ball. So when we were talking earlier about oil prices and then US dollar inflation, because 60% of the world’s commodities are priced in dollars. A strong US dollar is a problem very specifically for Europe. Europe has a number of economies, and maybe Netherlands is at the top of the list, but Germany as well, that are both export-oriented and they are very good capital reinvestment countries. The one that I would put at maybe the top of the list though, is Sweden. As a country that has done an incredibly good job at looking outside of the country in terms of reinvesting their profits. So I think the Swedish economy is probably the one to me that is most interesting as an investor.

Dave:
Oh, cool. Interesting. Wouldn’t have thought of that. All right. Well, Bill, this has been very fascinating, very helpful conversation and getting a better understanding of the global economy. Crystal ball time here. If you had to take a guess on how the global economy evolves over the next year, what’s your view?

Bill:
So I think it really is going to be based on a couple of things that are hard to predict. The first of which is India is really driving hard to become a manufacturing center in a very high-tech way. India, I would describe as the economy of the future, and it maybe always will be.

Dave:
Interesting.

Bill:
You can see now they’re trying to open up a very high-tech manufacturing area in Gujarat. At any point, particularly when you see a break in the past, the things that have been the drivers of the past, and I’m thinking specifically here of AI, of artificial intelligence, I think you have a real opportunity for advancements in parts of the economy that we haven’t really expected. I expect that probably we have come close to the end of the US Federal Reserve raising interest rates. So I think you’re going to see a little bit of a return to stability that will give companies a little bit of a longer… Their binoculars will look out a little bit farther so they can make some additional plans. You’re going to see some real redeployment, but I see the global economy moving back to a reasonable rate of inflation and GDP growth across the globe of three and a half to 4%.

Dave:
Well, Bill, let’s hope you’re right. I like your vision of the future. That sounds like a vision of the future we could all get behind.

Bill:
I’d vote for me.

Dave:
Yeah, if you could do it, I’d vote for you too. Well, Bill, you obviously, you are doing a lot of research, you make a lot of content. Where can people follow you if they want to learn more?

Bill:
So I run a few services at the Motley Fool. I have one called Global Partners, which is an international equities service, and I run another called Value Hunters, which is kind of scouring the globe and looking for companies that have been left behind.

Dave:
Treasures.

Bill:
Treasures, exactly.

Dave:
You’re finding the treasures.

Bill:
Should have just called it Treasures, yes. So those are the best places to find me and I’m on Motley Fool Money a couple days a week. That is our free podcast and radio show.

Dave:
Awesome. Well Bill, man, thank you so much for joining us. We really appreciate it.

Bill:
Thanks, Dave, I really appreciate the invitation.

Dave:
That was a lot of fun. Big thanks to Bill for joining us. Kailyn, our producer just Slacked me and is totally right. Bill has an excellent voice for radio. I don’t know what mine sounds like, but it’s definitely not as cool as Bill’s. But he really understands the economy. That was a lot of fun to listen to and talk to, and I found it super easy to digest and understand. Hopefully you did too, and if you have some feedback for us, we would love to hear it. We’re always trying to expand the show into new topics and new areas that our audience are curious about. This is a perfect example where we’re talking about equities, we’re talking a little bit about business, we’re talking about the global economy. And if this kind of show is interesting to you, we would love to hear about it.
Or if you’d prefer we stick to something else or you have an idea about a different kind of show that we could do, we would love to hear from you as well. You could do that by finding me on Instagram, where I’m @TheDataDeli, or you can also find me on BiggerPockets anytime. Thank you all so much for watching. We’ll see you for the next episode.
On The Market was created by me, Dave Meyer, and Kailyn Bennett. The show is produced by Kailyn Bennett, with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.