19 May 2019

Although stock markets have been reasonably well behaved, geopolitics is dominating the tone and US/China trade spat is now evolving into a full-on trade conflict with technology looking to take centre stage. Trade tensions have clearly escalated to market disruptive levels with Apple and its suppliers having already been sold off due to fears that any expansion in scope of US tariffs on Chinese imports which would this time encompass smartphones, displays, servers and other technology hardware. 

However, sentiment darkened further this week after the US announced that it is now banning its component makers to sell to Huawei without a special license. All eyes are now on China to see how policy makers retaliate with Apple looking the most obvious target in what could become a proxy trade war being played out in the global technology sector.  Should China respond by banning sales or worse yet, banning manufacturing of Apple's iPhones on its shores, then not only Apple's main assembler, Foxconn but its entire supply chain will be caught in this cross-fire.  

As we underlined last week, this sudden US change in stance on trade has changed everything in terms of our market outlook. These negative developments makes us much more cautious about tech and other cyclical stocks as hopes for 2nd half recovery fade away. Indeed, we suspect corporate confidence to have been severely dented from May onwards following the clear breakdown of trade negotiations.

Although tech sector has been the best performing segment among US stocks this year, these developments now leave some vulnerable to a growing possibility of two countries erecting a wall in trading in technology which could severely impact sales and profits. With risks rising in this segment, rich valuations leave them vulnerable to this highly fluid and politicised trade issue. 

This is a lose-lose scenario for everyone, not to mention, Japan as a key tech trading partner to both. In China, this will undoubtedly further accelerate its domestic developments efforts in key technologies to become more self-reliant more quickly. This is especially so, should the three US allies, Japan, Taiwan and South Korea, all side with it in controlling exports of key tech parts to Chinese firms. Moreover, if European countries like UK and Germany, not to mention, other Asian nations fold under US pressure to ban the use of Huawei equipment in telecom infrastructure, global 5G implementation will most likely to be greatly delayed. 

The US president also finally announced the findings of the US Commerce Department investigation which unsurprisingly claimed that imports of cars and car parts is a national security threat. The investigation explains that imports undermine domestic producers' profitability and thus future investments in research and development vital for technological changes facing the sector. Going by this logic, almost anything being imported to the US at competitive prices could be a national security threat.

However, Mr Trump announced that any tariffs on autos will be delayed for 180 days ahead of the US bilateral trade talks with Japan and EU. Clearly, the US Administration has its hands full with China and given this delayed time-line, things are not expected to be resolved anytime soon. However, by announcing the findings but delaying the tariffs which not many were anticipating in the first place, US has put both countries on notice.

We suspect Japan and EU are now likely to be less accommodative in the coming trade talks with the US as niceties will be put aside. The news that Japan and the US are unlikely to issue a joint statement after the meeting between Trump and Abe on 27th of May already reflects the growing strains of the coming trade talks, not to mention, Japanese complaints that the US is ignoring North Korea's most recent missile launches.

Should US go further and demand a currency provision in any trade agreement with Japan, then that would further strain ties as the Japanese law makers have warned that they will not agree to such demands as the yen is a free floating currency and MOF has not intervened in the currency markets for years. But in reality, Japan's PM is fully aware that any such agreement will put much pressure on BOJ to taper, potentially strengthening the yen which combined with the coming consumption tax hike in October could dip the economy into recession. 

As far as the Chinese are concerned, they no longer sound that interested in further talks with the US, at least for now. As we have noted, China will not be willing to negotiate with a gun to its head as Xi also wants to be seen as scoring political points in settling this important dispute and cannot possibly be seen as a leader of the weaker side.

Moreover, with Trump sensing that he has growing bipartisan support at home for his tough stance on China and has promised big subsidies to farmers affected by the trade conflict, we don't see much signs for either side to be toning it down any time soon. More concerning is that this conflict could easily spill over to beyond just trade as China could toughen its stance on South China Sea territorial issues, not to mention, forcing its hands on its Taiwan policy.