We had warned in our May 10th note about the rare earth element risk. It is one of the few remaining leverage points that China has left that has a potentially strong impact on the US much similar to the US’s impact on Huawei and perhaps even worse. Cutting the US off from rare earth elements is clearly worse than cutting Huawei off from technology as lack of rare earth elements would cut across many sectors, not just tech and many companies not just one.Yesterday President Xi visited a Rare Earth Element producer in China and clearly issued a lightly veiled threat relating to rare earth elements. Perhaps Xi read our May 10th note??
We would expect some sort of action on rare earth elements. It could be anything from a reduction in exports to the US, to an export tariff of rare earth elements (which US consumers will again pay for) or even an outright ban. We have seen this before in 2010 involving rare earth elements then being lifted in 2015 after which everyone promptly forgot…..
Taiwan is an hour and a half away from trouble
Taiwan is roughly 1.5 hours away from China by ferry and even less by faster naval vessel’s. Many years ago when China was flying missiles over the rogue , runaway nation and we wrote about the risk to the PC industry.
Today, the semiconductor industry centers around Taiwan and TSMC. We have been talking about this new risk for several years.
Could China, after being boxed in on trade by the US respond by sailing over to Taiwan and taking back what it claims is rightly theirs.
Sounds a lot like Russia “annexing” Crimea….no one…not even the US raised a finger to stop it other than some complaining.
Just like with Russia and Crimea, China can claim the common ancestry and language and former connectivity.
China has the excuse of saying that the US was threatening its future access to technology it deserves and thus could easily make excuses. Its not like the US is doing much about claims n the South China sea nor much progress in Korea.
Its pretty clear that both sides have dug in and continue to escalate….how far will the escalation go?
$16B for farmers….$0 for Semiconductors…..
The US seems to buy farmers off by paying them not to grow crops. Today the administration announced a $16B program to help out farmers hurt by the tariff war (paid for by US tax payers…).
Obviously soybeans are more strategically important than semiconductor chips as there were no semiconductor executives present at a press announcement of subsidies to US chip makers hurt by the US cutting off Huawei….they just have to suck it up….and sell billions fewer chips.
The impact on US chip makers is not a retaliatory move by a foreign government it is a direct order from the US government not to sell product for the strategic benefit of the security of the entire nation….might be worth a few pennies of compensation. It sounds like the US is going to lose a lot more than $16B in tech sales related to Huawei alone.
A Tariff on exported chips and equipment?…
Rather than forcing low end US consumers to pay more at Walmart for all the low cost Chinese goods that can’t be manufactured in the US for 25% more than current pricing perhaps it would make sense to have China pay the tariffs….like on stuff they really need.
They (Huawei and others) really need chips from US companies. Rather than cutting off the supply which hurts US chip makers why not just put an export tax to China on the components. In that way the US companies still get to sell product and the Chinese actually pay the tariffs, not just US consumers. Of course there will be trickle down and US consumers will eventually pay more but so will the rest of the world and Chinese consumers, not just US consumers.
While they are at it , why not put an export tax on US semiconductor equipment? China desperately needs it for made in China 2025 and they would likely have no choice but to pay the tariffs as Japanese, Korean and other equipment can’t make up. It would make Chinese fabs more expensive and thus less competitive. This would help make up for China’s price advantage due to labor or fewer regulations.
It would likely slow China’s expansion and allow the US, Japan, Korea & Taiwan to remain more competitive.
Food for thought……
We have just seen the tip of the iceberg of impact…….
The Huawei fallout while press worthy is small as compared to the impact of an all out trade war we seem to be headed for. Given the amount of technology goods and silicon that flows through China it could have a monsterous impact.
We have jumped from ZTE to Jinhua and now Huawei as we have graduated to larger targets.
Xi is threatening rare earth, and we are not far from 100% tariffs on all trade between the US and China.
The next step after tariffs is cutting off trade all together. Given China’s authoritarian regime they can do what they want, create any impact on the population without worry of complaint. The US does not quite have that luxury.
China can devalue its currency, it can sell US debt (but that is self defeating).
Mutually Assured Destruction-On an economic basis rather than Nuclear basis?
The Soviet Union and the US have an uneasy detente due to the premise of MAD (mutually assured destruction) if they were ever to unleash a nuclear war….it is “unwinnable”.
One of the problems facing the trade issue is that over the years the two economies have become so intertwined that MAD has become a reality for the Chinese and US economies.
An uneasy detente is likely the best outcome available, yet both sides seem to think they can “win” a trade war.
While I think the US can get much better trade terms than it has had in the past with China, it cannot “win” as China will not give in.
Further Downside risk for the stocks
The downturn in the semiconductor industry, which was primarily driven by weak memory and smart phone sales that saw its nadir around the end of the year could be mild as compared to the China risk.
Right now the stock market continues to discount a positive resolution to the trade issue even in the midst of a worsening situation.
We think that is not enough of a discount based on the probability of outcomes given the current trajectory.
There is no “quick fix” on the horizon. Each day brings new escalation. Permanent damage has clearly already been done as the level of mistrust has risen to high levels.
China will push made in China much , much harder now as it will seek sources outside of the US. However, we don’t see manufacturing moving back to the US any time soon as there remain many low cost areas outside the US and China to buy from.
The full effect of all the tariffs has yet to be even calculated before it can be felt by US companies.
We are very hard pressed to see any way that the current chip down cycle is not worsened and lengthened by the trade conflict. Its only a matter of how long and how deep.
We would point out that previous down cycle bottoms at the end of 2018 were under $30 for AMAT, $125 for LRCX, $82 for KLAC, $29 for MU. Intel has already returned to its low on its own. QCOM was trading at around $50.
This suggests significant potential further downside from an extended trade war most of which is certainly not reflected in the current stock prices.
We could continue to experience the “death by a thousand cuts” of ongoing negative trade news flow or a couple of larger events could trigger some sharper drop offs.
There are not a lot of places to hide in the stock market but technology and chips in general continue to take the brunt of the hit and lead the overall averages down.
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