12 May 2019

Having talked up the potential for a trade deal for months and the coming resolution between the two sides, Trump's two tweets late last weekend, calling for import tariffs of 25% on $200bn of Chinese goods entering the US have changed everything. This took us by a big surprise given that we had thought that both sides had come to some sort of an agreement on the basic framework for a trade resolution. This change in rhetoric sent the global stock markets into a tailspin and have now left hopes for a second half recovery in grave doubt.

With these tariffs coming to effect last Friday and the Trump administration going a step further by announcing that it has started the process of looking to raise duties on all the remaining $300bn of Chinese imports that the latest hikes have not covered, a full on trade war suddenly looks to be materialising.

Moreover, the US president has further politicised the matter by claiming that the Chinese side has been hoping for a change in the US trade stance after the next presidential election which they had hoped will see Democrats regain control of the White House. This has further hardened his stance while promising big subsidies for the US agricultural products should Chinese policy makers retaliate by cutting out purchases of soft commodities from US farmers. 

Although we are now entering a lose-lose scenario, it is now difficult to see the Chinese government making any major concessions with a gun to their head. Indeed, the Chinese side had been asking for all recent import tariffs imposed to be removed in the initial trade talks, with demands that US also meet some quantitative targets to raise imports of certain Chinese goods while asking for more time for more difficult matters like technology transfers and intellectual property issues to be discussed internally before being put into law.

Ultimately, the Vice Premier, Liu He had asked that any text of the deal should provide a "balance" to ensure "dignity" of both nations as the US president is not alone in wanting to look good in reaching any trade resolution. However, Trump's latest threats blows away any hopes for such an outcome.

In fact over the weekend, he had gone a step further in warning China that if they don't act now and soon, the US terms of trade will become even more severe. Although both sides have left the door open for more negotiations, the ever more hawkish tone adopted by Washington leaves China with very little room to compromise in our view and changes the whole scenario for what is to come.

Should US import duties expand further to encompass goods such as cellphones, notebook PCs, display panels, storage devices and printers which together represent over $100bn of goods, even then US tech firms such as Apple which until now had managed to escape the potential for higher import costs will surely be affected going forward. With a potential outcome of such deal becoming increasing binary and not at all knowing whether both sides have crossed the Rubicon, it is now difficult to retain our bullish stance on the recovery prospects of technology and factory automation names which have strongly outperformed the market this year in hope for a trade resolution. This forces us to adopt a much more cautious stance on cyclicals until we see more hopeful signs for cooler heads prevailing. 

With Uber's listing price coming at much weaker price levels than many had hoped last Friday, one specific Japan name which we want to address here is Softbank (9984) which we had entered into our short sell list on 14th of Feb just after its big move following its share buy back plans were announced. Despite all the excitements about its valuation gains that have inflated its quarterly earnings, we just don't see this as being a sustainable earnings growth model as it very much depends on market conditions.

Although Softbank's continued accounting changes and various creative works (which for example allowed it not to book $2bn of impairment charges of Sprint in its consolidated earnings) has kept its earnings on a steep growth track, the quality of that growth looks to us as deteriorating rapidly as it more or less counts on the market to continue paying hefty premiums for its IPOs, some of the big ones coming like WeWork also loss makers like Uber.