With the U.S. intensifying its battle via restrictions on exports of technology to China, the trade war is increasingly showing signs of becoming a tech war. Broad market reaction to the latest developments has been surprisingly subdued. Maybe investors believe the impact will be isolated to just Chinese tech firms? Or perhaps investors are hoping that tensions will soon ease? On both counts, I am sceptical.
Last week, the U.S. Commerce Department put Huawei, China’s most prominent technology firm, on an export blacklist which forbids U.S. companies from supplying software and components which are essential to its products. And not only does the ban restrict the sale of final goods to China, but it also restricts technology transfers through other avenues, including licensing deals. Google has announced that it will stop providing Huawei with its Android software to comply with the export restrictions.
Furthermore, Huawei will struggle to switch from U.S. to non-U.S. supplies. Foreign-made products in which U.S-origin technology comprises at least 25% of the value are also subject to U.S. export controls. Indeed, a German supplier has reportedly already stopped shipping some affected components to Huawei.
The U.S. administration’s determination to paralyse China’s aspirations to become a technology super-power is evident when you consider that its actions against Huawei are not only damaging to China’s technology sector, but also U.S. technology.
Several U.S. technology sub-sectors have significant exposure to China via supply chains. For many large U.S. chipmakers, more than 30% of their sales are in China, and for a few that number is closer to 60%. If the U.S. government chooses to roll out this “export control” strategy to more companies, the effect on U.S. tech could be devastating.
How significant could the impact be on the wider market? Consider that between April 2009 and October 2018, earnings growth for the MSCI ACWI index excluding technology was just under 400%, whereas for the MSCI tech sector alone it was over 950%. If the tech sector stumbles, the broader market stumbles.
Note too, the critical role of 5G in transforming industries ranging from transportation, energy, all the way to healthcare. Slowing China’s progress in 5G technology could inflict significant damage to potential global growth.
Technology firms aren’t the only ones feeling the brunt of these developments. Almost 50% of members of the American Chamber of Commerce in China say they are already experiencing slower customs clearance, more inspections and delayed approvals for licenses. What’s more, there have been murmurs of an informal boycott by Chinese consumers of U.S. products. Third quarter earnings guidance for U.S. multinationals may make for uncomfortable viewing.
Surely the risk of a significant market reaction would prompt President Trump to resolve the dispute. Over the past two weeks, negative market movements do appear to have led to more constructive dialogues from the U.S. administration (for example, the 90-day exemption for Huawei). And yet, there are two reasons to believe a short-term resolution to the tech war is unlikely.
First, when it comes to technology and defence related issues, not only is there a fair degree of consensus across Congress to be tough on China, but many large economies share America’s concerns about China’s practises. Pressure on President Trump to be lenient will be limited and he could even come under severe criticism for backing off.
Second, U.S. demands around technology and defence will be very difficult to meet given that they are focused on containing China’s aspirations to be a global technology leader, and therefore too existential for China to concede.
While a compromise on tariffs is still possible, investors should prepare for a longer, more hostile, technology war–with some meaningful collateral damage.
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