Semiconductors Hurt by Trade War

Semiconductors - Trade War Worries Continue

Semiconductors -The tech sector underperformed on Monday because of the fallout from the Commerce Department putting Huawei on its entity list. That prevents Huawei from buying American made parts and components. Blacklisting Huawei will have such a severe impact on American firms. 

Therefore, the government is trying to scale this back by offering a temporary general license to let Huawei service its existing customers. In 2018, Huawei spent $11 billion on components from American companies such as Intel, Qualcomm, and Micron.

The table below shows the 33 S&P 500 firms with the highest revenue exposure to China. As you can see Qualcomm and Micron are in trouble because they are affected by the Huawei fallout and they have high exposure to China. That explains why Qualcomm stock fell 5.99% and Micron stock fell 3.99%. 

Semiconductors ETF SOXX fell 3.99%. The ETF is now down 15.1% from its peak on April 24th. Some investors are claiming the collapse in this index is a sign the economy is weak. While the global economy is showing cracks, this industry is being hurt by the trade war more than others, so it can’t be as heavily relied upon as an indicator for the economy. Rather, it is an indicator of how bad the trade war has gotten.

Tesla Stock Falls Below $200

Semiconductors -It’s highly discussed whether China will sell its U.S. treasury bonds to hurt America. That probably won’t happen because China would end up weakening the dollar which would help America. Also, China’s percentage ownership of treasuries has declined in recent years. It’s more plausible that China somehow restricts American usage of rare Earth minerals, which among other things, are used to make batteries.

That would just add to Tesla’s long list of issues. Its stock fell 2.69% on Monday; it temporarily fell below $200 in the morning. The firm’s main issue is liquidity as it’s struggling to sell as many Model 3s as investors expected. The auto industry is weakening. 

It doesn’t take much to hurt a company that has already played hard and fast with profitability. Tesla’s bonds fell to 83 cents on the dollar as it was one of the biggest losers in the high yield market. Another selloff in the high yield bond market like late last year would be a big problem for Tesla.

Semiconductors -Market Correction Not Over

We've all seen headlines claiming the market has become more resilient to trade war worries. Personally, I think that’s misguided. I think the range of uncertainty has shrunk and investors have gotten used to the risk. However, that doesn’t mean the base case has improved. 

Once the impacts start being felt by the consumer in June, investors will care more. I don’t see investors ignoring weak economic data just because it could get better if the trade war is called off. Unfortunately, there’s no evidence of negotiations getting anywhere with China. 

That being said, the stock market will immediately react to any positive news 

Semiconductors -Even if it takes weeks for policy to be implemented and then effect the economy.

S&P 500 fell 0.67%, Nasdaq fell 1.46%, and Russell 2000 fell 0.7%. This correction isn’t over. The market won’t hit new highs unless there is positive news on trade or the economy improves. 

VIX increased 2.19% to 16.31 and the CNN fear and greed index fell 2 points to 34. If the market gets extremely oversold, we will see a snapback rally. But that doesn’t mean the correction is over.

As expected because of the trade war, the worst sector was tech which fell 1.75%. Real estate fell 1.62%. The best 2 sectors were the utilities and the financials which increased 0.17% and 0.14%. Utilities sector is 10 cents away from its record high close of $58.96. Financials liked the mini selloff in treasuries. 10 year and 2 year yields increased 2 basis points to 2.42% and 2.22%.

Oil Market In Backwardation

Semiconductors -As you can see from the chart below, Brent’s backwardation is the strongest since oil was $100 per barrel. 

Backwardation is when futures market prices are lower than the spot price. OPEC members are trying to tighten global inventories which is bullish for oil. Also, uncertainty on Iranian exports given the American sanctions could be a positive for oil. 

However, the big overhang is the negative impact on demand a trade war can have. I don’t see oil about to collapse the same way it did in 2014 and 2015 because there isn’t a supply glut like there was then. This backwardation basically serves as a warning for how much oil can collapse if there is a total global trade war. 

The crash in oil alone almost caused a recession in 2016. This time oil declining would only be part of the impact of a trade war. That’s why Morgan Stanley stated a global trade war could cause a global recession.

Semiconductors -Earnings Impact Of Global Trade War

To be clear, semiconductors aren’t the only stocks affected by the trade war. They are just the most impacted. The slide below reviews each potential risk to S&P 500 earnings. Personally, I don’t see 10% tariffs on $200 billion worth of imports from China as a base case. 25% tariffs on $200 billion in Chinese goods are already in place. 

As you can see, that will hurt S&P 500 earnings by 2%. Price increases of less than 1% would offset this impact.

The severe situation listed below, which is a 25% tariff on all Chinese goods, would hurt EPS by 6%. A price increase of 1% would offset this decline. Obviously, the later this tariff is put in place, the smaller the impact will be in 2019. I don’t expect it to be put in place for a few months. 

First, American tariffs will impact shipped Chinese goods next week. Then, China’s $60 billion tariff will affect America on June 1st. Next China and America will negotiate. Finally, if they don’t get anywhere, America will implement the 25% tariff on all goods.

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