Trump’s Trade War May be Coming to Tech & TelecomMar15

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Daily Intelligence Briefing – March 15, 2018

FEATURED TOPIC: Trump’s Trade War May be Coming to Tech

On Monday, President Trump issued an executive order blocking Broadcom’s $117 billion bid to gain control of Qualcomm. While Broadcom is a Singapore-based firm and the word “China” didn’t appear once in Trump’s executive order, it is apparent that the foremost purpose of this restriction is to prevent China from accelerating ahead in technology arms race.

The key issue at hand in this deal was 5G technology, a development that the US considers essential to its national security. Huawei, a Chinese leader in communications gear, had no direct role in the deal negotiations, but it loomed over the talks because of its growing influence as Nokia and Ericsson are grappling with weak telecoms spending. The Committee on Foreign Investment in the United States (CFIUS) is concerned that Broadcom would cut back on R&D funding at Qualcomm, opening the field of 5G standard-setting, and strengthening Huawei. Huawei also uses Broadcom’s chips in networking products such as switches that direct data traffic between connected computers.

The Trump administration wants to avoid a scenario wherein U.S. wireless carriers may be forced to turn to Huawei or other Chinese companies for cutting-edge telecoms gear. This is not the first time the U.S. Government has acted to prevent what they see as an attack on the nation’s intellectual property.

Back in January, congress proposed legislation seeking to ban any government agency from working with Huawei, citing several intelligence reports that these telecommunications companies are “subject to state influence”. A 2013 statement by General Michael Hayden of the CIA and NSA noted that the telecom company had shared sensitive information with the Chinese state. Then, a 2015 FBI report reiterated the concern that China’s government would be able to access U.S. business communications via Huawei technology. Two years later, in 2017, ZTE Corporation pled guilty to illegally shipping US-origin items to Iran, a violation of the International Emergency Economic Powers Act.

Further legislation proposed in U.S. Congress aims to broaden the powers of the CFIUS, providing an opportunity to expand the number of deals reviewed by the committee. Currently, the CFIUS review process is voluntary or by request, allowing a number of transaction participants to skirt their authority.

During the past 10 years, China’s investment in U.S. technology firms has amounted to approximately $35 billion. It is not just Huawei that the US may begin to stifle, but the acquisition aspirations of the broader Chinese tech sector as well. Back in September 2017, President Trump blocked a China-backed investor from buying America’s Lattice Semiconductor. The US government relies on Lattice’s products and raised concerns over state-backed entity China Venture Capital Fund Corporation’s involvement. More recently, CFIUS blocked the $580m acquisition of a testing equipment producer for the semiconductor and electronics manufacturing industry, Xcerra, by an affiliate of Sino IC Fund, another Chinese state-backed fund.

US chips have been put under especially tight security at a time when developing the semiconductor industry has become a key piece of Chinese president Xi Jinping’s “Made in China 2025” strategy to turn the world’s biggest exporter of manufactured goods into a leading high-technology player. This is largely because the 2025 initiative, along with 5G, is specifically focused on artificial intelligence and follows a similar national AI development plan released by the U.S. in 2016.

Beyond these recent defensive moves, America may be gearing to strike back offensively. President Trump is now seeking to impose tariffs on up to $60 billion of Chinese imports and will target the technology and telecommunications sectors. The tariffs, associated with a “Section 301” intellectual property investigation, under the 1974 U.S. Trade Act begun in August last year, could come “in the very near future”.

Trump is attempting to punish China for its investment policies that effectively force U.S. companies to give up their technology secrets in exchange for being allowed to operate in the country, as well as for other IP practices Washington considers unfair. While the tariffs would be chiefly targeted at information technology, consumer electronics and telecoms, they could be much broader and the list could eventually run to 100 products.

The U.S. can continue to block Chinese acquisitions, but may not be able to avoid adopting Chinese technology. China will likely own a meaningful share of 5G-essential patents and is already racing ahead in AI and deep learning patents. In the most extreme case of an all-out trade war, the U.S. could ban Qualcomm (and Intel) from selling chipsets to China, but China could retaliate by refusing to license any 5G-essential patents to US companies, or non-US companies that use them to build 5G for the US.

Trump has proven, through the implementation of broad steel and aluminum tariffs, that he does not fear undertaking indiscriminate measures to do what he believes will protect America’s national security. Although only a few shots have been fired, it could be indicative of a more substantial tech trade war to come.

Investors can gain exposure to US and Chinese telecoms and Semiconductors via the US Telecoms ETF (IYZ), China Tech ETF (QQQC), and the Semiconductor ETF (SOXX).

HERE IN THE MEANTIME are some articles relating to the tech trade war(the stories are summarized in the TECHNOLOGY section of today’s report):

• Trade War – The China Telecom Threat Is Patently Obvious
• Trade War – Without a comprehensive strategy to regulate foreign investment, China wins
• Trade War – Switching Lanes
• Trade War – Trump eyes tariffs on up to $60 billion Chinese goods; tech, telecoms, apparel targeted

CHART:  US Telecoms (IYZ) vs China Tech (QQQC) vs Semiconductors (SOXX) vs S&P 500 (SPY)

OTHER STORIES HIGHLIGHTED IN TODAY’S DIBS:

• Markets: 
  • Bonds – Not a Single Japanese 10-Year Bond Traded Tuesday
  • Bonds – This Is What a Broken Market Looks Like
  • Bonds – Subprime Auto Bonds Caught in Vise of Rising Costs, Bad Loans
  • FX – Mexican Currency Traders Are More Worried About Amlo Than Trump
  • Libor – Libor Rates Surging On Top Of Mounting Debt
• Economics and Trade: 
  • China – Will China’s high debt levels spark a financial crisis?
  • Trade – Trade Wars Weigh on Growth
• Politics and Policy: 
  • Italy – Italy’s Center-Right Leaders Agree to Talk to Five Star
• Finance: 
  • Banks – Standard Chartered launches digital-only bank in Ivory Coast
  • Banks – The Surprisingly Large Winners in a Bill to Help Small Banks
• Real Estate: 
  • 3DP Construction – 3D printing project aimed at revolutionizing low-cost housing
• Services: 
  • Advertising – These Are The Concerns Slowly Killing Ad-Tech
  • Gaming – Gaming is taking over Southeast Asia
• Technology: 
  • 5G – 5G will drive global infrastructure revenues up $25B by 2022, IHS forecasts
  • Aerospace – Satellite startup promises communications network that can’t be hacked
• Commodities: 
  • Oil – Canadian Oil Curve Indicates Relief From Glut May Be on the Way
  • Oil – Chinese Oil Production Hits Record Low
• Energy & Environment: 
  • Renewables – No More Room for the Little Guys in Latin America’s Clean Energy Market
• Endnote: 
  • Markets – Nowhere to Hide: No Asset Has a Positive Beta to the VIX

JOE MAC’S MARKET VIEWPOINT

• Joe Mac’s Market Viewpoint: The Coming Value Rotation
• Joe Mac’s Market Viewpoint: Beyond the BOND BUBBLE
• Joe Mac’s Market Viewpoint: A Review of MRP’s Latest Change-Driven Investment Themes
• Joe Mac’s Market Viewpoint: The Gathering Storm
• Joe Mac’s Market Viewpoint: Contrarian Crude Call

CURRENT MRP THEMES

About the DIBs: MRP focuses on identifying transformational change in the global economy and offering an investment thesis whenever an opportunity arises that has not yet been recognized by the market. The DIBs are MRP’s compilation of articles and data from multiple sources on subjects reflecting disruptive change that have potential investment implications for an industry or group of securities. We share these with our clients who may already have or may be considering exposure in the industries affected. The subjects change daily and constitute an excellent update on featured topics. 

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Bonds – Not a Single Japanese 10-Year Bond Traded Tuesday

Some jobs might be threatened by automation. But when it comes to government bond trading in Japan, the biggest threat might be the country’s central bank. The Bank of Japan has vacuumed up so much of the government bond market — in excess of 40% — that it’s left fewer securities for others to buy and sell. Some other buyers, such as pension funds and life insurers, also tend to follow buy-and-hold strategies.

That’s the backdrop to Tuesday’s session, when not a single benchmark 10-year note was traded on exchange. The upside for the BOJ is that with such little going on in the market, it makes it easier to control the yield curve, with less need for intervention. Governor Haruhiko Kuroda noted to lawmakers Wednesday that the central bank has bought 75% of the government bonds issued in the fiscal year ending this month.  B

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Bonds – This Is What a Broken Market Looks Like

Kuroda has cornered the JGB market. He owns 40% of it and on some issues, he’s damn near the only game in town. Suffice to say it’s not entirely clear how this market is going to respond if he ever pulls out. Recall the charts below that BofAML published last summer. They may be dated, but for what it’s worth, here’s the commentary that accompanied them last June:

“JGB transactions by megabanks in the secondary market have greatly declined since QQE was introduced. Before QQE, these transactions averaged slightly less than ¥30trn per month, but they have sunk by 90% to about ¥3trn recently. The JGB market’s volatility sharply declined after the introduction of YCC, giving the impression that the policy was working effectively.

However, in a market with reduced liquidity and activity, attention should be paid to the risk that a slight movement could send volatility much higher.“

That bolded bit is obviously key. The BoJ isn’t completely oblivious to this; indeed, it’s one reason why the so-called “stealth taper” will likely continue apace. Any nod to normalization is met almost immediately with an outsized FX reaction which further tightens financial conditions, making an exit even less plausible.  Heisenberg

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Bonds – Subprime Auto Bonds Caught in Vise of Rising Costs, Bad Loans

More Americans are falling behind on their car payments and that’s making it more expensive for subprime auto lenders to sell bundled loans. On average, AAA bond investors last year demanded insulation from the first 51% of losses on subprime-auto asset-backed securities, up more than seven percentage points from 2016. Prime lenders needed to offer enhancements on just 6%.

Delinquencies have steadily increased over the last five years, with losses rising to 8.32% for subprime-auto bonds in 2017 from 8.13% in 2016.

The need to boost costly credit enhancements eats away at already-thin profit margins at lenders struggling with deteriorating loan quality. Such a trend may leave the firms at risk if they run into financial trouble or an economic shock weakens borrowers further.

So far, lenders such as Exeter Finance, Foursight Capital and American Credit Acceptance haven’t seen any falloff in demand for the asset-backed securities as long as they add the extra safeguards to attain or bolster AAA ratings on the senior-most portion of the deals.

Subprime auto bonds have surpassed the pre-financial crisis peak as a share of the overall auto-ABS market. Last year, they represented about $25 billion out of total issuance of $110 billion.  B

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FX – Mexican Currency Traders Are More Worried About Amlo Than Trump

Investors in Mexico’s currency are pricing in more tumult around this year’s presidential election than they anticipated before the vote that elected Donald Trump in 2016.

The difference in price between short-term options and those covering the period around the July 1 election is near a record high as investors pay up to protect themselves against volatility. The spread’s four-week moving average is now twice the level it was three months before the U.S. ballot.

The top contender in Mexico’s vote is Andres Manuel Lopez Obrador, a left-leaning firebrand who some investors are concerned will seek to roll back efforts to open the economy, particularly the energy industry.

“As it stands, it looks like Amlo is going to win,” said a strategist at Rabobank, which predicts the peso will fall about 10% by the end of the second quarter to 20.67 per dollar. “International markets don’t welcome populist leaders unless that leader tends to be pro-business.” B

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Libor – Libor Rates Surging On Top Of Mounting Debt

3-month Libor rates have surged over 2%, the highest since 2008. In fact, Libor rates across all durations — from the 1-week to the 12-month Libor – have reached a cycle high. Meanwhile, the Libor-OIS spread, a key indicator of short-term liquidity and credit risk is soaring.

Libor is the average interest rate that each of lending banks in London estimates it would be charged were it to borrow from other banks. As short-term interest rates rise, so does the overnight rate. A rising Libor rate, however, can also indicate tightening credit and liquidity conditions. Banks are less willing to lend out overnight loans as market risks elevate.

So here’s the question: Are Libor rates surging due to true underlying economic weakness or is this something more benign?  

Each economic cycle shows a lower peak in Libor rates, similar to the Federal Funds rates, the 10-year Treasury rates, the nominal GDP growth rate and the inflation rate. All of these factors are correlated. As the chart below shows, the Libor rates are at the highest since 2008. SA

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China Debt – Will China’s high debt levels spark a financial crisis?

Multiple international organizations have expressed concerns about China’s ballooning debt levels and warned the Asian giant could face a full-blown financial crisis should there be no action to counter the problem.

The IMF estimates China’s overall debt figure to be about 234% of GDP, and predicts it will rise to 300% by 2022. Corporate debt currently stands at around 165% of GDP, and household debt is also spiraling upward at a rapid pace. Furthermore, systemic risks to the financial system have grown over the past several years due to the expanding role of the shadow-banking industry.

In a bid to tighten up the financial sector, regulators have initiated some steps that place the PBoC, China’s central bank, at the heart of the new regulatory structure for finance in China. Also, the China Banking Regulatory Commission and the China Insurance Regulatory Commission will be merged as part of an overhaul aimed at resolving unclear responsibilities & cross-regulation, as well as closing regulatory loopholes and curbing risk in the $43 trillion (€34.78 trillion) banking and insurance industries.

It’s too early to say how effective this new structure would be in tackling the country’s debt problem while ensuring that economic growth doesn’t decelerate. DW

Trade – Trade Wars Weigh on Growth

The charts below, from Goldman Sachs, show the effect on the U.S., European, Canadian and global economies of four different scenarios for a global trade spat. Those four scenarios are:

1) U.S. tariffs with no retaliation from abroad

2) Retaliation from abroad that focuses strictly on the U.S.

3) An all-out global tit-for-tat where everyone slaps 5% tariff on everyone else

4) Scenario 3 combined with a 10% drop in equities

What you want to note is that in no scenario are the tariffs a good idea. Even in the most benign case (i.e. the first scenario which assumes no one retaliates), the gains for the U.S. economy are negligible.

The point: avoiding all of that is key and Larry Kudlow, who is slated to replace Gary Cohn as the U.S.’ top economic adviser, has voiced his opposition to the tariffs. At the very least, he could serve as a counterbalance to trade hawk Peter Navarro. SA  

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Italy – Italy’s Center-Right Leaders Agree to Talk to Five Star

Italy’s center-right alliance led by the euroskeptic League has taken the first step toward negotiating with the anti-establishment Five Star Movement, raising the prospect of a populist administration which investors regard with alarm. A government of Five Star and the League would risk spooking financial markets and Italy’s European Union partners concerned about their spending plans and euro-skepticism.

Reportedly, the three parties in the center-right bloc all ruled out an accord to govern with the ruling Democrats, who scored their worst-ever result in the March 4 elections.

The choice of speakers for the lower house and the Senate, due from March 23, will be the first clue to possible alliances in the new parliament. League leader Matteo Salvini and Five Star leader Luigi Di Maio are both seeking support from other groups to form a majority.

Five Star emerged as the single biggest party after the elections, while the center-right alliance is the largest group overall. Both fell short of a majority. B

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Banks – Standard Chartered launches digital-only bank in Ivory Coast

Standard Chartered is launching its first digital-only retail bank in Ivory Coast, saying it will use the west African country as a testing ground for a global launch of digital services.The move is part of a fightback by banks in Africa, where telecoms and financial technology companies have grabbed market share from banks by offering services such as mobile money and mobile payments, often to previously unbanked customers.

In Ivory Coast, where it has no bricks-and-mortar retail presence, the new StanChart bank will offer clients 70 digital services, including money transfers, bill payments and balance tracking.

The French-speaking west African country of 24m people, which has been growing at about 7% a year for several years, has the fifth-highest mobile money penetration in the world. There are an estimated 9.8m mobile money accounts in the country registered with telecoms companies, including MTN of South Africa, Orange of France, and Etisalat.

Once the operation had bedded down, StanChart would launch a digital bank in other African markets, including Kenya, Nigeria and Ghana. StanChart has traditional retail banking operations in 10 African countries.  FT

Banks – The Surprisingly Large Winners in a Bill to Help Small Banks

Three of the biggest winners, in a bill meant to help small and midsize banks, are anything but. The bill would raise the threshold for stricter oversight by the Federal Reserve to $250 billion in assets from $50 billion, a boon for midsize regional lenders. It also contains measures to reduce the burden of regulation on smaller community banks.

Another group of banks that dwarf these small lenders stand to get a healthy profit boost if the bill goes through: the Bank of New York Mellon (BK) with $372 billion of assets; State Street (STT) with $238B; and Northern Trust (NTRS) at $139B. These so-called custody banks specialize in safekeeping the securities of institutional investors like mutual funds, so they manage or have under custody trillions of dollars of assets.

Under the bill, they would be able to exclude some deposits they hold at the Federal Reserve or other central banks from their total assets when calculating total leverage. The change could boost earnings per share at the two biggest custody banks by around 8%, assuming they use the freed-up capital to invest in other profit-generating assets. WSJ

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