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Alibaba Thinks the Market Is Overreacting to the Trade War

Jeremy Bowman, The Motley Fool

Alibaba Group Holding (NYSE: BABA) shares were moving higher Wednesday following its fourth-quarter report. The Chinese tech giant showed off revenue and earnings per share that topped estimates and maintained its long-held guidance of 500 billion yuan ($72.7 billion) in fiscal 2020, the current year.

However, arguably the most noteworthy item to come out of the earnings report wasn't in the financial results, but in comments made by executive vice chairman Joseph Tsai, who addressed concerns about the trade war between China and the United States on the earnings call.

The escalating standoff has captivated the market in recent weeks, sending stocks plunging in much of the world. Investors were taken aback on May 5 when President Donald Trump said that he would lift tariff rates from 10% to 25% on $200 billion worth of goods imported from China. It was a sudden reversal: Investors had expected a resolution after Treasury Secretary Steven Mnuchin said negotiations between the two sides were on their "final laps."

The unexpected twist pushed the S&P 500 down as much as 5%; China's Shanghai Composite has lost as much as 7.8%, after crashing more than 5% when the new round of tariffs was first announced.

Addressing the elephant in the room on the earnings call, Tsai sought to reassure Alibaba investors and the broader market, saying that "the trade talks put Alibaba on the right side of all the issues on the table." He said China was already taking steps and naturally shifting in the direction that Trump wanted, and discussed areas including the trade deficit, China's developing economy, and intellectual property. Let's take a closer look at what he had to say.

A boulder with the Alibaba logo outside the company headquarters

Image source: Alibaba.

On the trade deficit

The trade deficit with China has been a particular bugaboo for Trump, who believes that the U.S. is getting ripped off by China, which exports more goods to the U.S. than it imports.

On that topic, Tsai said: "China's commitment to purchase more American products means China will, over the next several years, become a net importing country." He singled out American farmers, brands, and small businesses as beneficiaries of this shift.

Tsai also called China's rising imports a "secular trend," meaning it would happen with or without the saber-rattling over trade. He sees it as a natural outcome from China's transition from a manufacturing economy to a services one, similar to the transition the U.S. experienced. Tsai noted that over the last five years, China lost 14 million manufacturing jobs but gained 70 million service jobs, which are driving its consumer economy.

On Chinese markets and growth

Along with concerns about the trade deficit, U.S. negotiators would also like to see less protection from China and more fair trade.

"The trade negotiations will lead to China opening its markets to more foreign businesses in order to satisfy the massively growing demands of domestic consumers," Tsai said. "We're not concerned about slowing China exports affecting GDP [gross domestic product] growth, because the Chinese economy is shifting from an export economy to a domestic consumption economy. Job expansion is continuing in China." He went on to predict that the middle class in China would double over the next ten years.

Clearly, Tsai does not think tariffs or the trade war will be severe enough to derail Chinese growth, as Alibaba just reported a quarter with 39% organic revenue growth, and predicts 33% revenue growth for the current year. Tsai's comments about GDP and the shift to a consumer economy are especially noteworthy for Americans investing in Chinese stocks, as the trade war has weighed on companies in both countries.

On intellectual property

Intellectual-property rights are a pain point for American companies, which complain about counterfeits and knockoff products, as well as being forced to divulge proprietary technology in order to do business in China.

Once again, Tsai sought to reassure investors that China was moving in the right direction. "In recent years, China has made significant improvements in reducing IP infringement, as China moves closer to global norms in protecting and paying for foreign IP," he said. "China also recognizes the need to protect its own innovators, as well as being focused on Chinese consumers who demand genuine products of high quality."

Tsai seems to believe that the IP concerns of American companies and the U.S. government are being resolved by separate forces as China evolves. That refrain -- that the trade war differences will clear up as a matter of course -- was the core message he wanted to leave with investors.

"The vexing issues in the trade negotiations will resolve themselves, as the Chinese economy is already evolving to close the gap between the interests of the United States and China," Tsai said. "This means in the future there will be bigger Chinese domestic consumption, more foreign imports, continuing focus on enhanced IP protection, and further digitization of industries driven by participation of the private sector."

What this means for investors

Tsai's words may just be one person's opinion on the trade war, but as one of the leaders of Alibaba, a titan of Chinese business, he has a valuable window into the machinations of the Chinese economy and the impact of trade tensions. He's also likely wary of a repeat of last year's performance, when Alibaba stock lost as much as a third of its value (along with much of the Chinese stock market) on concerns about a trade war and a slowing economy. So he was trying to assure his own investors as he made the argument that Alibaba was well-positioned for the economic shifts and other changes.

If Tsai is right, Chinese stocks should do well regardless of the outcome of the trade negotiations. However, when and how they're resolved is ultimately up to the leaders of the two countries. And plenty of American retailers and small businesses have made it clear that they're unhappy with the tariffs that will force them to raise prices.

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Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.