Market Insider

Here's why Huawei arrest is ripping the stock market

Key Points
  • Canadian officials arrested a prominent Chinese telecom executive at the behest of the U.S. government for violations of sanctions on Iran.
  • China has objected but U.S. officials have not said much about the arrest, seen as a new obstacle to any trade deal between the U.S. and China.
  • The development sent fear into financial markets across the globe, driving the Dow down more than 700 points at one point as investors sought safety in bonds.
  • The markets fear that trade talks between the U.S. and China could collapse, resulting in an escalation of a costly trade war that would slow global growth. 
Meng Wanzhou
Alexander Bibik | Reuters

The arrest of a high-profile Chinese telecom executive at the behest of the U.S. government sent fear into financial markets that it could complicate talks between the U.S. and China, reigniting trade wars and wreaking damage on the global economy.

Canadian officials arrested Huawei Technologies CFO Meng Wanzhou, the daughter of Ren Zhengfei, founder of the Chinese telecoms group, in Vancouver, on Saturday. Meng, also a deputy chairwoman of Huawei, faces extradition to the U.S. for alleged violations of sanctions on Iran.

The arrest took place the same day U.S. President Donald Trump and China President Xi Jinping met in Buenos Aires and agreed to a trade ceasefire for 90 days while the two sides negotiate. News of the arrest was reported Wednesday night, and it immediately hit U.S. stocks and sent global markets into a tailspin. The dollar weakened against major currencies.

"I'm shocked there's been no word from the administration. The market is down 450 points on this and there's not been one word," said Peter Boockvar, chief investment strategist of Bleakley Advisory Group."Imagine if the CFO of Apple was arrested by the Chinese in some foreign country, and the CFO happened to be the son of Steve Jobs. This is not some low-level person."

National Security Advisor John Bolton did comment in an interview with NPR that he knew about the arrest in advance but did not know if the president was aware. He would not discuss the particulars of the Meng case, but he did say the U.S. is not happy with Huawei.

"I'd rather not get into the specifics of law enforcement matters. But we've had enormous concerns for years about the— in this country — about the practice of Chinese firms to use stolen American intellectual property, to engage in forced technology transfers, and to be used as arms of the Chinese governments objectives in terms of information technology in particular. So not respecting this particular arrest, but Huawei is one company we've been concerned about. There are others as well. I think this is going to be a major subject of the negotiations that President Trump and President Xi Jinping agreed to in Buenos Aires," Bolton said to NPR.

Concerns about the trade talks have already been taking a toll on the market, with the Dow down nearly 800 points Tuesday. Markets were closed Wednesday for President George H.W. Bush's funeral service.

The Dow plunged more than 400 points on the market opening Thursday, and fell more than 750 points but erased some losses and was down about 400 again in afternoon trading. The , the Nasdaq and Russell 2000 were all officially in correction territory Thursday morning — or more than 10 percent off their highs. Nearly half the stocks in the S&P 500 are in bear market territory — down 20 percent or more.

"For those that are fixated on U.S. China relations, i think it's a problem," said Jack Ablin, CIO at Cresset Wealth Management. While it's unclear, how the arrest will impact talks, it elevates uncertainty.

"When you have the world's largest economy in a trade war with the world's second largest economy, it's going to leave a mark. I just don't know how large a mark it's going to be. What was originally thought to be a tactic quickly morphed into a strategy, and and now investors worry it's turning into policy, and I don't think that's what President Trump anticipated," Ablin said.

Huawei is viewed as one of China's most successful technology firms, and Deutsche Bank says that the arrest puts Beijing in an "awkward position."

"Public opinion in China will likely become more negative in respect to the trade war, and potentially against US companies. The government may find it difficult to tell the public that they have offered significant concessions to the US. The trade talk has just been resumed at the G20 meeting; now its outlook has darkened," Deutsche analysts wrote..

Markets fall hard

Investors indiscriminately dumped stocks around the world, with the German DAX off more than 3 percent, and now also in a bear market. Japan's Nikkei was down nearly 2 percent and Shanghai off 1.7 percent, while EEM, the MSCI Emerging Markets ETF, fell 1.9 percent.

"It looks like this was somewhat of a surprise to China as well. So then you say, what motivation does China really have to negotiate at this point. I'm not saying they won't. It certainly calls it into question," said Jim Caron, portfolio manager and fixed income strategist at Morgan Stanley Investment Management.

Investors sought safety in bonds, driving Treasury and German bund yields lower. Yields move opposite price, and the 10-year Treasury yield was at 2.83 percent, the lowest since August. Expectations among investors also moved dramatically for Fed rate hikes, with the market now seeing less than 70 percent chance for a Fed hike in December, a given just a few days ago.

The markets have been sorting through concerns about global growth with signs that the U.S. economy is entering a phase of slowing growth and China's growth slowdown is already spilling over onto other economies. At the same time, a more than 30 percent decline in oil prices since early October has sent shudders through markets.

Trade wars are the wild card, and some strategists say it's much more likely the economy will teeter if trade remains an uncertainty.

Battle over trade and tech

Canadian officials said the U.S. was seeking extradition of Meng, who faces a bail hearing Friday. The case is being handled by the U.S. Attorney in the Eastern District of New York.

The Financial Times reported that the U.S. was seeking Meng in a criminal probe related to the alleged selling of U.S.-made equipment to Iran, according to sources. The newspaper said sources close to Huawei said the company had sold telecoms equipment to Iran that included U.S. parts, but the sales ended after UN sanctions on Iran were imposed. The current sanctions against Iran are leveled only by the U.S.

Reuters reported the U.S. probe also was looking at an alleged scheme to use the global banking system to evade Iran sanctions.

The Chinese government has protested the arrest. Huawei is one company at the heart of the rivalry between the U.S. and China on tech. The U.S. has been worried about Chinese dominance of 5G, the next-generation cellular technology.

Huawei is the fifth-largest buyer of semiconductors in the world, though its impact on Advanced Micro Devices, Nvidia and some other U.S. chip makers would be negligible, according to Bernstein analsyts.

Xi was seen as protecting the company when he denied Qualcomm's merger with NXP last summer, according to the Wall Street Journal.

The U.S. had also banned China's No. 2 telecom company ZTE for violating sanctions against Iran and North Korea, but the ban was lifted after ZTE paid a penalty.

The Journal recently reported that the U.S. government, according to sources, has been encouraging its allies to avoid Huawei equipment due to espionage risks. The equipment is widely used in major markets like Germany and Japan.

An unclear outlook ahead

Peter Donisanu, global market strategist at Wells Fargo, said the U.S. and Chinese posture toward trade talks remains positive. The U.S. also has pressed China on cyber security issues and the protection of U.S. intellectual property along with its trade concerns.

"There are still all these different actors that have their own agenda, and all the things they want to get done. Maybe a trade deal isn't a priority for them. The are just doing their job," he said. "I don't think the Canadian government was in cahoots with the U.S. to try to pinch this executive to give more leverage to the U.S. president. I think this is just something that happened."

Marc Chandler, Bannockburn Global Forex chief market strategist, said the Chinese may have known about the arrest while Xi and Trump were speaking. But even so, there were positives in the post-meeting comments. "It's possible it was incompetence, but we have to assume it's not," he said of the arrest.

Donisanu said market expectations were way too high for the weekend's G-20 summit by expecting a conclusion.

"In reality, these trade deals take a long time. From our perspective, the G-20 meeting provided a framework to start those discussions. That's why we have 90 days...This is just the start of the negotiations. Where we go from here is really unclear."

"I think just inflames the tension that investors are fixating on right now. It has a lot o do with sovereignty and dominance. This issue personifies the trade dispute," Cresset's Ablin said. "The fact we're trying to impose who they can trade with and that obviously runs counter to what China is looking to do and also the technology dominance."