Global trade wars could take a bite out of Apple

Investors have a problem. Two of the most important economic powers are at war. As tensions escalate, both sides are being pushed to more extreme measures.

The U.S. Commerce Department announced Oct. 29 that American companies will no longer be permitted to sell components and technologies to Fujian Jinhua Circuit Co., a leading Chinese semiconductor company.

It is a surgical strike, and Trade Wars 101. Mutual destruction is a distinct possibility.

For decades, Chinese political leaders have committed to globalization. They supplied access to cheap labor. They reduced regulation. This helped them attract companies from around the world that wanted to offshore at least part of their operations.

These moves re-industrialized China. In the process, countless millions of Chinese have been lifted from poverty into the middle class. Today, China’s high-single-digit gross domestic product growth is the envy of the developed world.

President Xi, its popular leader, has a new vision. Made in China 2025 is dedicated to moving the country up the value chain in 10 key sectors. Xi wants China to be a global leader in technology-forward sectors like robotics, biotechnology, self-driving vehicles, semiconductors, aerospace, renewable power generation and agriculture.

It is an ambitious agenda that local companies have embraced. CNBC reported in August that Chinese firms added 87,000 industrial robots in 2017. That figure is near the combined purchases of Europe and the U.S. during the same time frame.

On one hand, retooling Chinese factories with the latest gear is a longer-term competitive threat to other countries. On the other hand, the country has become a major buyer of high technology.

IC Insights, a semiconductor industry research firm, notes China is the world’s leading buyer of semiconductors. The country consumes $140 billion, or 38%, of the world’s integrated circuits. And the trajectory is only straight up from here. Xi has signaled his government is prepared to commit $161 billion over 10 years to develop homegrown chip companies.

The decision by the Commerce Department to block sales to Fujian Jinhua may be in the longer-term best interests of the United States.

But in the near term, it is devastating for American technology companies. It removes a major buyer, which in turn creates a supply glut.

Ultimately, lower prices will follow. This hurts stakeholders.

For a long time, investors ignored the U.S./Sino trade dispute. Many assumed the tariffs and tough talk were all just bluster, a bargaining tactic. The calculus was that officials on both sides would eventually come to their senses because further escalation meant mutually assured destruction.

It is now clear a larger agenda is at play. There will be no ceasefire. Not anytime soon.

Peter Navarro, director of trade and industrial policy for the White House, told CNN Business, “If we lose our industries of the future, we lose our future.” For the Trump administration, maintaining strong competitive advantages over China is not enough. Officials view Chinese innovation as an existential threat. They want to shut it down. They want the de-industrialization of China.

Given this stark choice, investors should prepare for the trade war to ultimately get much hotter and claim more victims.

Apple (AAPL) was largely unscathed in October’s carnage, but it seems to be only a matter of time before it gets caught in the crosshairs.

The iPhone maker has built an impressive Chinese business. In the fiscal third quarter, Apple had $9.5 billion in sales in greater China, an increase of 19% year-over-year. More important, its entire supply chain is located in Asia.

Tim Cook, chief executive officer, cut his teeth overseeing the development of relationships with Chinese and Far East suppliers. As Apple production scaled, managing its global supply chain has contributed mightily to the bottom line.

Cook says he has been assured by President Trump that no tariffs will be applied to Apple products. The Apple leader also a longstanding, cozy relationship with President Xi. He was one of a small group of American and Chinese business leaders who attended a lecture that Xi gave recently about innovation and reform.

However, that was before the trade war escalated. Investors should be aware Apple might become a victim of extreme measures.

Related story: Why Apple is so focused on busting innovators

The stock is still up 26% in 2018. Its market capitalization remains above $1 trillion. Be careful.

Best wishes,
Jon D. Markman

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