Tech Suppliers Prove That Market Thinks Trade Deal Will Happen

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The market as a whole might be hurting after the recent trade war escalation, but tech stocks in particular have had an especially bad stretch over the last few weeks.

The SPDRs Select Sector Technology ETF (NYSE: XLK) is down almost 8% for the month of May, exceeding the month-to-date losses of the S&P (5.40%), Dow (5.40%), and even the Nasdaq Composite (6.90%).

Investors are understandably worried about a prolonged economic conflict between two world superpowers, and things only got worse last week after the U.S. blacklisted Huawei, forcing some American corporations (like Facebook [NASDAQ: FB]) to alter their dealings with the Chinese tech giant.

But if everyone was truly convinced that a full-on “worst case scenario” was in the works – one that would result in a global recession – wouldn’t tech stocks be collapsing as we speak?

Sure, they’re falling, and long-time shareholders of the FAANG collective certainly aren’t happy, but relatively speaking, the recent tech dip hasn’t been so bad.

Don’t forget, the XLK fell 8.00% in October of last year following a Fed rate-hike – something arguably more detrimental to the market than tariffs on Chinese imports.

And at one point in December, the XLK was down more than 15%, as investors buckled down for what (looked like at the time) was going to be a rough 2019.

Of course, a post-Christmas “gift” came for market bulls, ultimately saving the XLK from double digit losses and putting the monthly drop at a much more palatable 8.77%.

Still, though, a near 8% loss for the current month is nothing to be happy about, even when compared to past tech sector crunches.

But the comparatively less severe drop could also be confirmation that market participants, on average, think trade negotiations could be reaching a better than expected conclusion.

Several analysts agree with that sentiment, like Pierre Ferragu from New Street Research. In a recent report, he called the current climate, “Risky but positive!”

“[Washington] threw the Huawei ‘tactical nuke’ to bring the negotiation back to equal ground,” remarked Ferragu.

“On that basis, our main read on the ban, is that it signals a likely rapid conclusion of negotiation.”

And though it might be easy to dismiss Ferragu’s statement as unfounded optimism, recent price movement from several key companies has lent credibility to his argument.

Ever since the U.S. blacklisted Huawei – forcing American companies to ask permission from Uncle Sam to do business with them – the more than 50 suppliers to Apple (NASDAQ: AAPL), in aggregate, have only fallen 2.5%.

That’s worse than the 2% drop of the Nasdaq composite over the same time period, but it’s an extremely mild reaction when you consider the implications of an “all-or-nothing”, scorched earth trade war focused squarely on U.S. and Chinese tech companies.

China’s “ace in the hole” in this case is the reliance of American tech corporations on Chinese goods and services, ranging from manufacturing to their supply of “rare earths” – minerals required for almost all handheld electronic devices.

If China flips the switch, cutting off all business with American tech companies, mutually assured destruction would result, annihilating tech stocks both in the U.S. and Shanghai.

But it gets worse.

“Huawei consumes nearly 10% of the world’s semiconductor output and is a global leader in smartphones and telecommunications equipment,” wrote an analyst at Investec Asset Management, a South Africa-based financial services company.

“It has revenues of over $100 billion and employs nearly 200,000 people.”

China currently assembles more than 80% of the handheld devices worldwide, and along with Taiwan, produce a staggering 96% of iPhone components according to market research from Morgan Stanley.

Apple especially has an enormous amount of “skin” in the game in the Far East, but has fallen only about 5% since the (now modified) Huawei ban went into effect.

So, it could easily be argued that in general, American tech companies (even tertiary suppliers) aren’t really suffering as much as they should be if a full-scale trade war was on the horizon.

If we’re truly headed for a “no agreement” conclusion to all of this, then the XLK would be cratering.

Or at least, it should be.

And yes, market participants could simply be complacent right now, having grown sluggish after enjoying such an impressive 2019 rally to cap off a raucous 3-year run.

If that’s the case, then expect an even bigger collapse down the road if American tech is truly in danger. Based on market performance alone, though, it looks like investors are still confident in a more positive ending.

Because if tech in the U.S. falls off a cliff, China’s economy would likely get smashed as well. And even though both sides of the conflict have done plenty of posturing over the last year, a widespread economic contraction would be disastrous for everyone – egos and political parties be damned.

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