Market Insider

U.S.-China tensions are expected to rise and increasingly weigh on the technology sector

Key Points
  • U.S.-China relations are worsening and analysts say technology shares, in particular, could be vulnerable to retaliation from Beijing.
  • President Donald Trump said the U.S. would end its special treatment of Hong Kong, and now investors are watching for a response ahead of Monday morning trading.
  • Technology is most vulnerable because of its revenue exposure and supply chain issues.
People wearing protective masks wait for checking their temperature in an Apple Store, in Shanghai, China, as the country is hit by an outbreak of the novel coronavirus, February 21, 2020.
Aly Song | Reuters

The rising tensions between the U.S. and China could continue to hang over the technology sector, even though President Donald Trump on Friday stopped short of threatening Beijing with more trade actions.

The president said the U.S. was ending its preferential treatment of Hong Kong and terminated the U.S. relationship with the World Health Organization because it did not act aggressively enough to prevent the global spread of the coronavirus. The action on Hong Kong was taken in response to Beijing's imposition of a new security law on Hong Kong.

The action is intended to revoke Hong Kong's special treatment as a  separate customs and travel territory from the rest of China and was made in response to Beijing's move to impose new national security powers over Hong Kong.

Stocks rose on Friday afternoon after Trump's comments because he did not ratchet up trade tensions, while condemning China's actions. The semiconductor sector is at the heart of the U.S.-Chinese technology relationship, and the VanEck Vectors Semiconductor ETF jumped to close up 2%.

"If he had done something more heavy handed, if he had done something to change the phase one trade deal, that would have been the fear that the market had started pricing in," said Paul Christopher, head of global market strategy at Wells Fargo Investment Institute. 

The S&P 500 closed up a half percent at 3,044 after trading lower earlier in the day. Now traders are watching to see if China responds ahead of Monday trading.

"Basically, the items he could have talked about he chose not to talk about, but it's not an end point. It's a continuation on the way to more tensions," said Julian Emanuel, BTIG head of equity and derivatives strategy. Emanuel said the technology sector is most vulnerable because of the supply chain being so dependent on Chinese manufacturing and also because the tech companies have the most revenue exposure.

China's Global Times called Trump's action as "reckless" and "arbitrary."

"It's another instance in which at least one side has issued punitive measures that were very carefully designed not to damage the home economy," Christopher said. "We'll see what the Chinese do next. The Chinese could do quite a lot to complicate life for executives and managers working out of China, or supply chains operating out of China. So far they haven't done that."

China could use an anti-monopoly law to impact the operations of companies and industries where China does not have a a large market share. "Electronics is one and anything to do with computers is another area where Chinese domestic companies have struggled ... to catch up to the U.S. The Chinese government might try to bring the U.S. down a peg," he said. 

""As long as the U.S. continues to be careful with its punitive measures, then China will probably act in similar fashion," Christopher said. Beyond tech, industrial companies could also be at risk, he added.

China has remained committed to the trade deal.

In a report to the National People's Congress last week, Chinese Premier Li Keqiang vowed that Beijing will work toward the liberalization of global trade and investment. He specifically acknowledged that China will work with the U.S. to implement the phase one trade deal.

In Washington last week, the Senate passed a bill by unanimous consent that could result in the delisting of Chinese companies. It would require companies to certify that they are not owned or controlled by a foreign government. It would also require the Securities and Exchange Commission to bar trading in any stock where the auditor hasn't been inspected by the the Public Company Accounting Oversight Board for three years in a row.

Analysts expect as the election nears, Trump is likely to become even more aggressive on China and his rival former Vice President Joe Biden is likely to also take a negative stance on Beijing, as China has become a bigger concern among voters of both parties. The U.S. is expected to continue to seek to protect U.S. technology.

But as the situation escalates, there are more risks for markets. 

"You don't want to see the two largest economies butting heads, regardless of  who is in the right and who is wrong," said Peter Boockvar, chief investment strategist at Bleakley Advisory Group. He said the U.S. semiconductor industry can credit much of its growth in the past year ot the fact that China has been a big customer, as it seeks to build its own industry.

U.S. actions against Huawei has been an ongoing source of friction. The U.S. limited sales of American supplies to the Chinese firm a year ago because it believed the firm was engaging in cyber espionage. Earlier this month, it cracked down even further with new rules aimed at Huawei's in-house chips. China is expected to push development of its own industry to supply the telecommunications giant.

Trump's actions were not unexpected or as severe as they could have been. "If all of a sudden in Chinese media, they're telling people 'do not buy iPhones,' you know this has taken on some serious implications," said Boockvar. Analysts see Apple as a potentially vulnerable stock because of its large revenue base in China and its manufacturing there, but the fact its partners provide jobs for hundreds of thousands of Chinese workers may also help it avoid any retaliation aimed at the U.S.

JP Morgan strategists said they became less bullish on stocks because of the China tensions and concerns that the economic reopenings will not be wide enough to justify the market's rally. In a worst-case scenario, a break in U.S.-China relations would have a very severe impact on stocks.

 "A complete breakdown of supply chains and international trade, primarily between the two largest economies (US and China), would justify equities trading drastically lower," the JPMorgan analysts wrote in a note. "As the market staged a substantial rally (nearly ~40%) since our out-of-consensus bullish call, we are dialing down our positive outlook on equities and would like to see these political risks show signs of normalization."