Huawei arrest complicates trade talks

Thought of the day

by Chief Investment Office 06 Dec 2018

Risk assets sold off Thursday following the unexpected arrest of a high-profile Chinese tech executive in Canada. Offshore Chinese stocks fell 2.5%, while S&P futures shed as much as 1.9% ahead of the US open. The reported detainment of Meng Wanzhou – Huawei’s Deputy Chair, CFO and daughter of the company’s founder – raised fears that the recently-agreed trade truce between the US and China might not last.

We believe the arrest could have implications for three key fault lines in US-China relations:

  • Trade negotiations. The detention of the Huawei deputy chair complicates trade talks, and risks bringing to a head conflicts over tech export controls, economic espionage, and forced intellectual property transfers. The charges in Huawei’s case are similar to those brought against China's telecom firm ZTE earlier this year, and threaten to heighten fear in Beijing that the US is simply trying to contain China’s rise.
  • Fundamentals. Huawei is one of China’s largest tech firms, earning six times the revenue of ZTE last year, and is the first and second largest global maker of telecom equipment and smartphones, respectively. Any penalties on its US component purchases would have a significant impact on the US and Asian semiconductor and hardware supply chain. On the bright side, it could be marginally positive for its European and South Korean competitors.
  • Market sentiment. Asia Pacific stock valuations have already been beaten down by months of trade tensions, with the MSCI Asia ex-Japan trading just 20% above crisis-level price-to-book ratios. Another significant leg down may require a more significant deterioration in US-China relations, while domestic Chinese stimulus should offer support.Before the Huawei arrest, we had warned investors we could not rule out another escalation in trade tensions, and put a 35% probability on this downside case. Our base case remains for incremental improvements to relations and a series of partial agreements, which should prevent or at least delay a ramp-up in tariffs and countermeasures. We remain overweight offshore China equities in our Asia portfolios, and expect Chinese policy support and solid corporate fundamentals to offset pickups in volatility.

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