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Wall Street gripped by fear that Donald Trump's China tariff escalation will disrupt Apple's tech supply chain

South China Morning Post logo South China Morning Post 20/5/2019 Jodi Xu Klein, US Correspondent

Investors in Apple's iPhone and its supply chain are taking no chances when it comes to the next stage of the US-China trade war.

Even long-time China bulls such as large investor Thornburg Investment Management are bailing out of Apple and the companies in its supply chain, worrying that new rounds of US tariffs, if imposed, could severely affect the tech ecosystem.

In the wake of the last-minute collapse of a deal to end the months-long US-China trade war, the Trump administration threatened to impose 25 per cent tariffs on all US$300 billion of US imports from China.

The move would raise the price of key components that go into one of the world’s most coveted smartphones, which is Apple’s biggest revenue driver.

The administration’s warning came after the import tax rate increased on Friday on a portion of US$200 billion of Chinese goods.

“The announced tariffs, if implemented, will be the gut punch for tech companies and its suppliers,” said Dan Ives, a New York-based tech analyst at Wedbush Securities. “That would cause a supply chain disruption and depress the sector throughout next year.”

Recent White House actions have indicated that US President Donald Trump is more inclined to implement punitive measures against China, rather than stick to his earlier strategy of using threats to gain a negotiating edge, an approach that had spared the iPhone.

Amid the growing tensions, outflows from Chinese equities have ballooned. Investors withdrew more than US$2.56 billion from Chinese shares in the week ended May 10, the biggest exodus of capital since October 2015, according to weekly data from the Institute of International Finance.

As of Thursday, another US$1.95 billion had left the marketplace. IIF does not provide specific data on outflows from the tech sector.

Beyond tariffs, US hawks are pursuing a broader decoupling to end a China relationship now perceived as a long-term threat.

Their moves include asking American companies to shift factories to countries outside China, restricting Chinese investment in the US and severing academic ties with China.

a group of people standing in front of a crowd: Donald Trump’s order to ban telecoms gear by companies deemed a security threat indirectly targeted China’s Huawei. Photo: Bloomberg © Bloomberg Donald Trump’s order to ban telecoms gear by companies deemed a security threat indirectly targeted China’s Huawei. Photo: Bloomberg

US relations with China again took on an antagonistic tone on Wednesday when Trump signed an executive order to ban the use of telecommunications equipment made by companies that are deemed a threat to national security, clearing the way for an outright ban on products made by Huawei.

The US Commerce Department said soon after the signing ceremony that it was adding Huawei, the world’s largest telecoms equipment producer, and 68 of its affiliates, to a blacklist.

Being placed on the list means the privately owned Chinese giant will now be required to obtain a US government licence to buy American technology.

a hand holding a cell phone: Mobile phones would be an important target of the tariff increases, because of their potential to disrupt the Apple supply chain. Photo: AP © AP Mobile phones would be an important target of the tariff increases, because of their potential to disrupt the Apple supply chain. Photo: AP

The recent show of bipartisan cheering for Trump’s tough China policies is rare in Washington, where Republicans and Democrats have been at odds for more than two years over numerous domestic and foreign issues.

In a CNBC interview on Thursday, political commentator Thomas Friedman, who advocates worldwide interaction between people, companies and governments, and former White House Chief Strategist Steve Bannon, an anti-global champion, saw eye to eye on Trump’s dealings with China.

“China’s business model is an existential threat to Western democracy,” Bannon said.

Friedman said, “we all need to be lined up shoulders to shoulders on this”, adding that US allies must join the fight against China.

Mobile phones are the key item to be put on the latest list of products to be targeted by tariff increases, because of their potential to disrupt the Apple supply chain. The phones were dropped from the previous round of tariff hikes after heavy lobbying by the tech industry and Apple CEO Tim Cook.

But the tariffs could take effect after Trump meets his Chinese counterpart, Xi Jinping, in late June at the upcoming G20 summit in Japan.

Despite the recent drop in Chinese demand, the iPhone still has about an 11 per cent share of the Chinese smartphone market, with 400 million phones being shipped in 2018.

With some 60 million to 70 million iPhones over the next 12 to 18 months expected to get updates – representing 20 per cent of all iPhone upgrades – China remains “the growth linchpin region for Apple”, Wedbush’s Ives said.

a close up of Stephen K. Bannon wearing glasses: Steve Bannon says hopes that Trump and Xi can reach a tariff ceasefire at the G20 summit are unrealistic. Photo: AP © AP Steve Bannon says hopes that Trump and Xi can reach a tariff ceasefire at the G20 summit are unrealistic. Photo: AP

The Cupertino, California-based tech giant sources, makes and sells tens of millions of iPhones annually in China, where it is exposed to tariffs at both ends when the phones are produced and sold.

New duties could cut into profits if Apple chose to absorb the costs rather than pass them along to customers; otherwise, they threaten to undercut consumer demand.

So when the US imposed tariff increases on US$200 billion of Chinese goods on May 10, after Trump accused China of reneging on agreed terms that would have ended the trade war, Apple shares took a beating.

Within two trading days, the stock dropped nearly 7 per cent, wiping more than US$60 billion off its market value.

Tim Cook wearing glasses: Some investors are betting that Apple CEO Tim Cook’s proven ability to placate politicians and lobby groups will help the company ride out the crisis. Photo: SCMP Pictures © SCMP Pictures Some investors are betting that Apple CEO Tim Cook’s proven ability to placate politicians and lobby groups will help the company ride out the crisis. Photo: SCMP Pictures

“The stock drop wasn’t about the tariffs on US$200 billion [of Chinese goods], it was about the fear of what comes next,” Ives said.

“With the current tariffs, the Apple ecosystem is relatively unscathed. If a draconian scenario comes to fruition [such as additional tariffs taking effect], iPhone prices will have to go up by 20 per cent.”

Investors’ Apple worries have had a ripple effect, weighing on scores of Chinese iPhone suppliers.

A recent Nikkei Asian Review report showed Chinese suppliers have recently become Apple’s top suppliers, outnumbering US companies for the first time.

Among the most vulnerable supporting players is Foxconn Technology, which assembles Apple devices at plants on the mainland and in Taiwan.

Xi Jinping wearing a suit and tie standing in front of a flag: Trump with China’s president Xi Jinping in Beijing in 2017. The show of bipartisan cheering for the US leader’s tough China policies is rare. Photo: Reuters © Reuters Trump with China’s president Xi Jinping in Beijing in 2017. The show of bipartisan cheering for the US leader’s tough China policies is rare. Photo: Reuters

Also exposed to Apple’s potential woes are audio-parts maker Shenzhen Sunway Communication and electronic connector maker Luxshare Precision Industry, according to Di Zhou, a Santa Fe, New Mexico-based portfolio manager at Thornburg, which manages US$44 billion of US assets.

“We are avoiding sectors that have large exporting elements, for example, the entire iPhone supply chain,” Zhou said.

Since the latest tariffs were announced on May 10, shares of Foxconn have fallen 8 per cent. Shenzhen Sunway and Luxshare have dropped 11 per cent and 14 per cent, respectively.

a large building: Foxconn assembles Apple devices at plants on the mainland and Taiwan (shown). Photo: AFP © AFP Foxconn assembles Apple devices at plants on the mainland and Taiwan (shown). Photo: AFP

The US$4 billion international equity fund that Zhou manages is 20 per cent made up of Chinese stocks, its top holding. These stocks have done well for the fund, contributing to 7.7 per cent returns so far this year, beating the MSCI Equity benchmark.

Zhou said she is now focused on Chinese industry leaders – Tencent and Alibaba, for example – that buy and sell products and services almost exclusively within China, and are therefore shielded from the tariffs’ impact.

Alibaba owns the South China Morning Post.

a group of people walking in front of a building: Despite falling demand, the iPhone still has an 11 per cent share of the Chinese smartphone market. Photo: Reuters © Reuters Despite falling demand, the iPhone still has an 11 per cent share of the Chinese smartphone market. Photo: Reuters

Some investors see the G20, where Trump and Xi are expected to meet, as the next turning point in the trade war, hoping it can keep the next tranche of tariffs from happening.

Others are betting on what they see as Cook’s proven ability to navigate “Trump and K Street” – referring to the Washington thoroughfare known as a centre for lobbyists and advocacy groups – and gambling that Apple’s “strategic importance domestically” will help the company and its supply chain ride out the crisis.

“I am hoping at the G20, cool heads will prevail,” Ives said.

Trump said on Wednesday he was undecided whether to impose additional tariffs on the rest of China's imports.

But the administration has set the process in motion, registering the list with the Office of the US Trade Representative, a prelude to putting the new duties into effect.

Bannon’s CNBC comments suggested hopes that a tariff ceasefire could be reached at G20 were unrealistic.

The trade war solution “is not gonna take place at the G20,” the outspoken former Trump adviser said. “The differences are too fundamental.”

 

This article originally appeared on the South China Morning Post (SCMP), the leading news media reporting on China and Asia. For more SCMP stories, please download our mobile app, follow us on Twitter, and like us on Facebook.

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.

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