Tech Trade War Stakes Are Rising

I spent last week in China at the Huawei Connect technology conference, which brings together technology partners from all over the world. It was interesting timing. With trade rhetoric escalating after the U.S. levied $200 billion in tariffs on Chinese exports and the the Chinese responded in kind with $60 billion in tariffs, the potential trade war is a topic that's on everybody's mind.

It's a high-stakes poker game.

I asked questions about this. How will the poker game play out? The Chinese executives I spoke with were not optimistic. They pointed to the aggressive tone of the negotiation from the Trump Administration and said it's unlikely that the Communist Party of China (CCP) will cave easily, especially if it could be perceived as a sign of weakness. That's not the Chinese way.

They seem nonplussed by the fact that Chinese stock markets are collapsing. It's about pride.

On the plane home, I got to read a volley of stories about the doom. The Americans and the Chinese are entering a "New Cold-War Era," declared the Wall Street Journal.

It wasn't that cold in Shanghai. In fact, it was sunny, about 70 degrees. And the dumplings were excellent.

But on Wall Street, the climate is different. Volatility in the market has been rising, with technology shares receiving the brunt of the punishment. Some high-flying tech stocks have already sank as much as 20% in the past few months. That's a direct result of the uncertainty over the escalating trade ware between the United States and China.

Trillions in Value at Stake

The US and China are the two engines of global tech. The uneasy partnership has created trillions of dollars in value. Apple's trillion dollar market capitalization would not exist without $1,000 iPhones powered by low-cost components and manufacturing supplied by China.

What about manufacturing in Texas. $2,000 iPhone anyone? It ain't gonna happen. It just doesn't work that way.

Technology companies relay on a complicated global web of supply chains to supply the parts to build almost all tech products. This week, trade tariff started to make it's way into chatter about Q3 earnings, where analysts raised concerns about the potential impact on the bottom line as tariffs take hold.

For example, Simon Leopold of Raymond James had this to write about ARRIS Communications:

"We take our rating on ARRIS to Outperform from Strong Buy based on our view that it will be a victim of tariffs applied to its modem unit. We believe ARRIS will have to absorb at least a portion of new tariffs, now at 10% and stepping up to 25% in January."

In other words, tariffs could immediately lead a rise in costs of components and manufacturing. Most technology companies have said its very difficult to pass on costs to their consumers. So the result will either be: 1) Less profits or 2) Inflation.

The stress will be present in many tech industries supplying communications and networking. The Wall Street Journal reported recently that communications firms believe a protracted trade war will delay the rollout of 5G services.

U.S.-based companies won't support a mass move of manufacturing to the United States, because that is not a viable option. They'll look at moving to other Asian countries.

The Trump administration has built in an escalation in the tariffs from 10% now to 25% in 2019 if no resolution is reached by year-end, which automatically ratchets up the pressure on negotiations, which are expected to resume with a US-China Summit expected in November.

Embrace the Volatility

You may have noticed, this has contributed to volatility in the markets -- including tech shares.

The tensions have also contributed to the demise of cross-border trade and M&A. The mega-billion-dollar Qualcomm-NXP deal was scuttled in part due to the inability to gain approval from the Chinese government. Although the Chinese have less leverage in the trade negotiation, because they export more than they import, it's clear they think they have other toolkits in their negotiators bag -- including oversight on mergers and trade deals.

Many American tech executives have come out against tariffs, because it could have a wide-ranging impact on their business. Michael Dell, CEO and Founder of Dell Technologies, called it a path of “mutually assured destruction." Cisco CEO Chuck Robbins has also expressed concern, saying it will result in rising prices for tech goods. The market, at least this week, seems to agree.

This is why you see the volatility rising on your screen. The next two months are going to be crucial for the ongoing evolution of the global technology markets and the long-lasting symbiotic trade relationship between the US and China.

Hopefully, folks on both sides will dial back the rhetoric, be respectful, and come to the table in a good faith effort to get things right.