Clear Headed Thinking Amidst Tariff Confusion

The fear of tariffs is leading investors to make false predictions, causing distortion to the financial markets. At best, we’re a month away from an agreement, so speculation is unhealthy. We’re taking the approach of sober analysis based on what is known rather than speculation. The framework of our view is based on the US Trade Perspective along with factoring in the real goal of tariffs. Separately, we revisit the potential impact on Apple as an example of our rationale.

Bottom line: It’s going to take time (45–90 days) for this to sort out due to the multi-step bureaucracy of enacting global trade reform. The broader impact, however, will likely not be as negative as investors fear. The next window for progress will likely follow the June 28th G20 summit.

The US Trade Perspective

This is not a market event, but a geopolitical one. The negotiations lay the groundwork for where these countries want to be in 25 years. The Chinese want to lay the foundation to be the leader in telecom, AI, and aerospace. On the flip side, the US wants to maintain leadership in these segments.

China is gaining economic strength, as evidenced by them joining the World Trade Organization in 2001. Since then, the US and other countries’ trade officials believe China has not been abiding by trade agreements. An example of this is selling products in the US at a price lower than the price in China (“dumping”) and manipulating their currency, which has made the price of Chinese goods cheaper in the US. The US supports an economically stronger China but one that plays by an agreed upon set of trade rules. It’s likely that last week’s trade talks stalled when US trade officials asked China to create domestic legislation to ensure compliance with the agreement.

The Goal of Tariffs

Markets don’t like uncertainty, which in part explains why Monday’s trading session eliminated $1.4 trillion of the market cap, about 3x more than the combined proposed US ($325B) and China ($60B) increases in tariffs. We see a gross misunderstanding regarding the mechanics of these tariffs. The goal of levying tariffs on China is to sanction China-based companies selling competing products in the US. These sanctions will bring to light illegal trade behavior. For example, a steel supplier in China is at a high risk of increased tariffs because they are competing with US-based steel producers. Similarly, a phone manufacturer like Huawei is at high risk of increased tariffs, given its products compete with the iPhone.

Indications Suggest Apple Has Little Risk

Despite the widespread speculation related to which products and companies will be impacted, the truth is no one knows how this will play out. Even after we hear details from the Office of the United States Trade Representative (USTR), the impact will still be in question, given the uncertainty about how consumers will react. In the case of Apple, there are similar unknowns, but we do have 3 indications that the company is at little risk. First, US policymakers aim to protect US companies, and Apple is the most successful US company in China. Second, Apple has historically avoided tariffs. Third, it is unlikely that China would impose import tariffs on US goods manufactured in China as that would discourage US companies from manufacturing there. Keep in mind, Apple indirectly employs about 1m Chinese workers to assemble its products.

That said, we view Apple’s biggest risk coming from Chinese consumers boycotting Apple products to damage what is a symbol of US success in China. In the Dec-18 quarter, there were calls on China social media to boycott Apple products due to growing trade disputes with the US along with the arrest of Huawei CFO Sabrina Man in Canada (which triggered a boycott of Canada Goose Holdings). This may have played a role in China iPhone units declining 40% y/y in Dec-18 after being up nearly 20% yy in Sep-18 (Loup estimates).

Disclaimer: We actively write about the themes in which we invest or may invest: virtual reality, augmented reality, artificial intelligence, and robotics. From time to time, we may write about companies that are in our portfolio. As managers of the portfolio, we may earn carried interest, management fees or other compensation from such portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making any investment decisions and provided solely for informational purposes. We hold no obligation to update any of our projections and the content on this site should not be relied upon. We express no warranties about any estimates or opinions we make.