How a trade war with China could hurt the tech industry

  • The technology sector's high exposure to China has left Wall Street waiting for the next shoe to drop on tariff announcements.
  • For now, it seems like the tech industry is safe, since most information and communication technology was exempted from the U.S. proposal.
  • But if trade tensions escalate, there are more ways the technology sector could be hurt by tariffs and other trade-related regulations, analysts tell CNBC.

The U.S. and China have been engaged in a war of words, each threatening to levy heavy taxes on each other's imports — and the tech sector could be staring down the barrel.

So far, most information and communication technology has been exempted from the U.S. proposal. But tensions are starting to trickle into tech.

U.S. officials on Monday banned American companies from selling to Chinese phone maker ZTE, hinting at further protectionist measures and stripping American chip leader Qualcomm of a key customer.

U.S. President Donald Trump chats with Chinese President Xi Jinping in November 2017.
Andy Wong | AP
U.S. President Donald Trump chats with Chinese President Xi Jinping in November 2017.

Tech sectors with strong links between China and the U.S., like semiconductors, are vulnerable to additional rounds of proposed tariffs.

Analysts say it's hard to separate any threats to semiconductors — the "brains" and processing power behind everything from smartphones to car consoles — from the larger tech industry.

"We have been inundated with requests from clients to discuss our views on [semiconductors] as it relates to the escalating trade tensions between the U.S. and China," Credit Suisse analyst John Pitzer wrote earlier this month. "Predicating all the potential moves on a single Chess board is difficult – this feels more like 3-D chess."

If trade tensions escalate, there are more ways the technology sector could be hurt, analysts told CNBC.

Stock market rotation

If investors try to hedge their bets against a trade war, technology stocks might not provide the safe haven that traders have come to see it as, since many are already expensive and have hit new all-time highs this year.

J.P. Morgan analysts said they are taking a "cautious stance on Tech sector, which has elaborate supply chains, is sensitive to consumer and corporate confidence, and where the adverse trade impact could be material." They added that soaring technology stocks have had "such a dramatic run already."

That means investors might take profit and move money to safer bets that have room to grow.

"Also in the U.S., valuations do not provide a cushion anymore," the analysts wrote in a research note. "Given the years of outperformance and demanding valuations, we believe that investors should lock the profits in technology sector."

Guilt by association

The technology sector may see more pressure if industries that use chips — such as transportation, machinery or even security cameras — fall under higher taxes, Credit Suisse's Pitzer wrote.

Dan Harris, author of the China Law Blog, noted that the "guilty by association" motif goes beyond just being associated with a taxed sector. Any American brand that Chinese consumers associate with the trade tensions could have its marketing marred, too.

In 2008, for instance, Chinese consumers burned the French flag at protests outside Carrefour retail locations, saying the company was supporting pro-Tibetan independence groups. In 2012, sales of Toyota and Honda tumbled over a territorial dispute between China and Japan. Trade talks between Norway and China were snuffed over political backlash related to the Nobel Prize to jailed dissident Liu Xiaobo.

"Every time it's happened, the Chinese government has stirred the pot," Harris said.

Harris also said that companies with physical storefronts, like retail and restaurants, are most likely to be hurt by anti-American sentiment.

Still, many U.S. technology companies, particularly Apple, get a large chunk of revenue from China.

Measures beyond tariffs 

Harris said China could get stricter on laws other than tariffs as part of a larger crackdown on U.S. companies. For instance, over the past year, China has increasingly tracked and expelled foreign companies, especially American enterprises, that don't have their legal documents sorted out in China.

China could also allow American tech companies to stay but make it much more costly and much more difficult to maintain shops in China, said GBH Insights' Dan Ives.

U.S. tech giants like Apple and Intel are the most vulnerable to higher infrastructure costs or additional red tape, as huge portions of their supply chains operate in China and are staffed by Chinese workers.

Despite the tense rhetoric, though, it's unlikely that Chinese officials would "shoot themselves in the foot" that way, Ives said.

Expansion of business-to-business tariffs

The tariff proposals so far will impact consumer products most, Ives said, but a new round of proposed tariffs could broaden the risk to include business-to-business sales.

China leads the world in consumption of semiconductors, accounting for 40 to 50 percent of global demand, Raymond James' Chris Caso said.

Chinese giants like Alibaba, Baidu and Huawei count on American chipmakers for supplies. If China decides to match the U.S. government's proposed tariffs on semiconductors, American firms could lose key customers.

"Outside Apple, very few U.S. technology companies — from Google, to Facebook, to Microsoft — have had success selling in China," he said. "I think it's very possible that the next ratchet up piece of this is going much more into the IP side of things and much more on the B2B."

A means to protect IP

A second round of proposed tariffs on Chinese goods would likely take greater steps to protect American intellectual property, according to several analysts.

"While the focus today is trade, the real agenda is to protect U.S. [intellectual property]," Pitzer wrote, noting that current litigation playing out in China could further inflame U.S.-China tensions over IP.

A White House spokesman in March announced the intention to assign tariffs explicitly in response to "China's state-led, market-distorting efforts to force, pressure, and steal U.S. technologies and intellectual property."

But the first round of proposed tariffs don't yet achieve that goal, Ives said, suggesting looming risk for tech companies.

Future American laws limiting information sharing with China could clamp down on the U.S. technology sector, said John Vinh, equity research analyst at KeyBanc Capital Markets.

That could limit the spread of 5G internet connectivity, which has been led by American companies like Qualcomm and Texas Instruments. Cloud computing and machine learning could also be vulnerable to regulation, even as they face growing Chinese competition from Alibaba, Baidu, Tencent and Huawei, Vinh said.

The Wall Street Journal reported on Monday that cloud computing could be a target for trade regulators.

"[I]t's at least possible that the U.S. could restrict the sale of semiconductors targeted toward key technologies, such as 5G or artificial intelligence, where Chinese [manufacturers] such as Huawei and ZTE undoubtedly wish to participate," Caso wrote.

"[I]t would be impossible to put such restrictions in place without far-reaching collateral damage. ... [Chips] used in products across dozens of other sectors .... could come to a halt if export restrictions were put in place."

Disclosure: KeyBanc Capital Markets expects to receive or intends to seek compensation for investment banking services for Qualcomm-affiliated NXP Semiconductors and Apple suppliers Qorvo and Skyworks. It also makes a market in those securities.