CNBC Year-End Special with Brian Sullivan

Raging COVID in China reduces medium-term economic uncertainty but will worsen US/China conflict for years to come.

Summary: Late last year (the day before yesterday) I spoke with Brian Sullivan and AEI’s Derek Scissors about the impact of the overwhelming tsunami of COVID infections now sweeping across China on the things investor’s worry about. You can see the short video by clicking here or by clicking on the screen shot below.

I love working with Brian Sullivan. He is the most intellectually curious journalist I know and a master at delivering complex ideas in language we can all understand. Thursday, our topic was the dire situation in China, where COVID is burning its way through a population already fatigued from their Zero-COVID fiasco. Although the abrupt flip from Zero-COVID to tsunami-COVID has created a massive healthcare crisis in China and worsened supply chain problems today, it will reduce uncertainty for investors and increase growth in the Chinese economy in 2023 and 2024. But the aftermath of this crisis will be social instability in China and a more aggressive Chinese foreign policy for years to come.

I write a set of rough talking points before the show so the producers can brief the anchor on what’s on my mind. I have pasted the full set of (unedited) briefing notes below for your entertainment. As you will see, they cover my conversation with Brian in the video and several additional lines of argument that we didn’t have time to talk about. I will write separate pieces on two of them—why you should expect to be whipsawed by policy reversals in countries run by autocratic leaders, and what the long-term system effects of the COVID pandemic mean for social unrest, political conflict, and wars among nations.

Thanks for reading.

Dr. John

Note to Readers: When CNBC asks me to do a show, here’s what I send to the producers so they can brief the anchors on what I will say. I have copied/pasted it just as I send it, typos and all, to give you a look behind the curtain. I always try to give them more than we can use on the show so Brian and the other anchors have a choice. I will be writing posts on these subjects later this week to fill in the blanks:

Rutledge Talking Points

1. Situation

• China is in a massive healthcare crisis

• No way to get accurate metrics due to government cover ups

• unverified, leaked notes from yesterday’s NHC National Health Commission meeting (reported by FT/Bloomberg)

• 250 MILLION new cases 1st 20 days December. (18% of China’s population)

• that’s 4000x the 62K official reported cases. 8 official deaths in December.

• 37 MILLION new cases Tuesday 12/27. (Official data 5ooo cases/day)

• more than 50% people infected in Beijing, Shanghai

• hospitals, clinics, pharmacies, funeral services overwhelmed

• -black market in fever medicines (aspirin, Tylenol, Advil etc.)

• The small supply of Pfizer’s Paxlovid is not available to public. Reports of Paxlovid "gifts” to senior officials

• Largely of their own making.

• China’s (attenuated virus) vaccines less effective, especially with Omicron

• refused western vaccines (mRNA). (National pride?)

• bought minimal doses of Paxlovid.

• People living through their 2nd crisis of the year.

• Shanghai 2 month lockdown. Mass testing.

• Mass demonstrations against lockdowns in Guangdong, …

• Workers revolt at Foxconn factory city in Zhengzhou. Broke out of compound and left for villages

• worker shortages, hiring bonuses, iPhone production shortfall, etc. 6 million iPhones not produced.

• This is just getting started. The next month is going to be a nightmare.

2.Analysis

• China has dropped travel restrictions after Jan 8.

• US, Japan, Taiwan, India have imposed mandatory negative tests. More will do so.

• The spike will come and go much faster than happened here due to

• mass infection will leave herd immunity in its wake.

• lack of medical equipment (ventilators) means deaths will be much faster.

• Back to back crises have undermined people’s trust in government, data, institutions.

• look for more demonstrations…

• The hit to Chinese GDP will be quick (some Q4; mostly Q1/23) followed by rapid recovery

• Supply chain issues worse in short term but much improved after Q1.

• Embarrassing for Xi Jinping

• Expect more aggressive foreign policy to shift blame/attention (Taiwan saber rattling, Russia cooperation)

• Expect more meddling in Africa, Latin America (Wang Qishan attending Lula inauguration in 2 days)

• Don’t think there is a way the CCP can/will throw him out. He has built fire walls around his position

• Elsewhere, more drama.

• Russia/Ukraine will grind on.

• I believe Putin will be gone a year from today.

• Market implications.

• Some immediate commodity/energy weakness but will be reversed as China growth outlook improved

3. There are 3 COVID stories.

• The COVID pandemic itself.

• Long COVID (the medical after-effects), the documented neurobiological impact on people, labor supply, etc.

• Systemic Long COVID. This is the big one. In history, pandemics have been followed by periods of lawlessness and disorder, the result of undermining their faith in institutions and each other. They make big things happen. They are often violent. They breed wars and conflict.

• Political fighting in the US

• Russia/Ukraine

• Demonstrations in Iran

• China demonstrations

4. Investment Strategy

• Overall effect of reversing Zero-COVOD is to REDUCE uncertainty for investors. We know how this will play out.

• Demand pressure on commodities (oil/gas/copper/lithium…) will reassert itself in 2023

• inflation will decline here faster than many think (4% by spring)

• Fed will back away from tightening and QE IMHO

• US/China problem won’t go away for a very long time

• Russia problem won’t go away either

• we are running out of weapons in our inventories.

• there will be a massive buildup of missiles, ammunition, equipment over next few years.

• Must have in portfolios. Lockheed, Raytheon, Northrup.

• EU gas shortage won’t go away either. They need LNG, LNG terminals

• Best bet is Equinor (EQNR, the old Statoil), now Europe’s largest gas supplier

• I think Taiwan will remain intact and new fabs will be in US, EU, India,…

• That means must have some TSM, AMAT, ASML too

• Until the Fed drama plays out I like the safety of big dividends

• As a contrarian choice, buy APPL during any drops due to Foxconn China crisis. Ecosystem, stock buybacks unmatched.