May Alert: The Real Trade Deal Reality is Now Here

We have been deep in the weeds on gaming out Huawei Blacklisting


Dear Subscriber,

Just a quick update. We have been getting as much data and analysis in from China and semiconductor land on possible scenarios here. One scenario happened this morning--"magically" after imposing a literal death sentence on $120 billion a year Huawei--the MOST important Chinese tech company (for context--imagine China imposing the same death sentence on Apple) we get a 90-day "extension" which appears strangely like the same routine imposed with ZTE in 2017. That tactic looked a bit like the "Trump Put" aka a market sensitive reaction. 

But this move confirms our base case assumption: This whole shit show is tactical: 1) impose death sentence blacklisting for US chip components and then 2) Use a stay of execution as leverage to get the Chinese back to the bargaining table.

I'll have a lot more on the full May NL issue--we are deeply exploring all aspects of this collision of economies. 

BUT I'm sending this alert out to simply say "nobody makes money when you are in a panic."

About this time yesterday, panic set in for many who just bailed out of all stocks to avoid analysing the reality of the cold trade war turning into a shooting war (metaphorically--if you blacklist China's most important tech company from US components, that is the equivalent of dropping a nuclear bomb on the 10,000 acre Huawei campus with 300,000 employees). ZTE came very close to insolvency after just 90 days on the blacklist--we now know Huawei has been stockpiling components in anticipation of this trading tactic since Q3 2018 and most probably has 1-2 year supply in the US components that are irreplaceable. 

But--with chip sales peaking in Q3 2018--the semi-space has pulled forward a LOT of 2019 demand into 2018 and first half 2019. How much? Still working on that. Huawei does not buy GPUs from AMD or Nvidia--and they have to buy FPGA chips from Xilinx for their 5G network boxes. BUT if Xilinx winds up on the blacklist, and it sells a ton of their FPGA chips to Huawei in this cooling off period, that sets up a great Q3 but lousy Q4. 

All investors must keep in mind--there is a long game here and a short game being played. China has a whole lot more levers to pull economically/fiscally/monetarily/politically than the split Congress US does. They also have a very powerful X factor: the nationalistic fervor of the Chinese consumer indoctrinated over many decades to rally against Imperialist bullying and threats. The power of the Chinese nationalism must NOT be undervalued. I remember well being in Beijing on business when the news of Korea installing the US made THAAD anti-missile system outside of Seoul. China had a fit--it believes these systems interfere with the security of its own military operations (which I frankly never understood since this system defends only against INCOMING missiles). Beijing would "firmly take necessary measures to uphold our interests", foreign ministry spokesman Geng Shuang said.

But the real reaction was getting the Chinese people riled up in patriotic and anti-Korean fever--and they revolted against Korean products sold in China. The Lotte grocery chain --they reportedly had invested over $9 billion in stores all over China--lost 72% of their weekly sales in the next month. When those sales did not come back--they left China and their $9 billion. Korean cars and appliances suffered too (and still suffer)--except for K-Pop and Korean softcore soap operas--modern Chinese cannot LIVE without K-pop and soap operas (you have to spend some time there and see what the government "entertainment" channels and stations offer to understand the Chinese love of Korean pop culture.)

Anyway--scenario 1 is now the most likely--the Huawei and ZTE blacklisting are negotiating TACTICS versus long term policy. They are still disruptive of course--and they continue to have negative economic ramifications on corporate confidence aka capital spending on new equipment/factories and capital goods. US corporate capital spending rose just 3% from last year in the first quarter--down from the 20% gain in the same time period 2018 (obviously juiced by the 40% corporate tax cut). 

The quick 180 on Huawei blacklist also seems to reinforce the second geopolitical case--the "Trump Put" on the stock market appears to still be in full force. We seem to have come up with a binary for Mr. Trump--is he the "Tariffman" or "Dowman"?  There is, of course, inherent conflict and tension between his desire position himself as a "tough guy fighting for the white working class low skill manufacturing jobs"  and to "make China pay for ripping us off for 20 years" (btw--I have no disagreement about the indisputable facts that China has never complied with the trade rules it agreed to follow with its WTO inclusion in 1995) and "DowMan" aka Mr. Trump's obsession with the stock market as the key measurement of success metric of his economic policies.

The facts are you can't be both. Initiating a full-blown trade war in the real economy (and make no mistake--blacklisting Huawei would be a metaphorical nuclear bomb strike in the China tech economy) will not play well on Wall Street for all the obvious reasons. A full-blown trade war creates a negative feedback loop for tech and industrial stocks who sell into China--lowered guidance and multi-national corporate capital spending then missed forecasts and the analyst re-valuations--there is no escaping this market reality.

IN the real economy, the higher consumer and intermediate goods costs create very real consumer goods price inflation which puts the Fed in a bind--cutting Fed funds rates with a price inflation spiral in consumer goods? And a long term shutdown in farmed goods to China means ever lower prices for already strapped farmers. 

I am reasonably sure that SOMEONE the POTUS actually listens to has pointed out Tariffman and Dowman cannot co-exist simultaneously. I am reasonably sure that someone has pointed out tot he POTUS that if China stopped shipments of its rare earth minerals and metals that US tech companies would be over a barrel and suffer greatly--from semiconductors to automobiles. China controls 92% of the world's rare earth metals--if Mr. Trump weaponizes US semiconductors to "win" a trade war, I am quite sure Mr. Xi will weaponize rare earth metals in response. 

Point 2 here--the whole melodrama/reality show theatre of this political masculinity and "face" saving is not a game in China. Face, or miàn zi, is a commonly-used term with regard to Chinese culture but it can be hard for Westerners and non-Asians to completely grasp and understand. Here is an example of how Face works in business and negotiations in China: "When a client relationship is established in China, the client more often than not receives more Face in the early stages of a relationship from the “seller.” Face must be given to the client to make him or her believe that the seller is worthy of their money and time. Sometimes giving Face to a contact entails simply words and compliments, though sometimes gifts are required and invitations to dinners, entertainment, or other social events.

To the Chinese, there is a natural order in society as well as business, and if one is unwilling or unable to show the proper amount of Face to those that feel they deserve it, then one will likely be judged to not have good character. This has the potential to wreck business deals and sour relationships, so with regard to the issue of Face most Chinese business people tread with care."

Here is a great example of how Face works in your private and professional life in China from a sales manager in Shanghai. “To me, your “face” is your position and standing in the eyes of others, and it also has to do with the degree of respect you receive. Face can also be saved up over time and used to accomplish things later on. If you drove a fashionable or luxurious car to attend a friend’s party, then the majority of your friends would feel that you had face. Also, if you can achieve something through your personal contacts that others cannot through normal channels, you would also be thought to have face. You can gain face if you are praised by your boss, or if you accomplish a difficult task at work. However, if you greet others warmly at social events, but are met only with indifference, then you would lose face. Questioning someone’s  ideas or opinion in a public setting would cause that person to lose face.”

– James Tan, Sales Manager, Shanghai

Among the many lessons I learned in my days in China is this one-- don't fuck with the Face thang--it will kill a deal dead if you do. To say this more politely, to understand Face means you show respect to others and do nothing to have them lose face in the eyes of their family, employees or in the case of elected officials, their public.

This Face thing requires nuance and sublimation of your ego. After interviewing Mr. Trump in person many times for Fox Business (as a program host) I can tell you will 100% certainty I have never seen either personality trait in Mr. Trump. We have obviously not seen evidence of nuance or ego sublimation with POTUS Trump either. 

Key point: I hope the other members of the negotiating team well understand the Face game in China--because if they don't successful negotiations are not going to happen.

I am hopeful--2020 is a big time for China (70 year anniversary of Communist Party) and of course our POTUS election. That Mr. Xi announced today that he wants China to launch "The Next Long March" is, however,  NOT very nuanced. His speech, at the same place the Chinese Communists retreated over 1000 miles to during WWII, is more than symbolic. It is a very overt message to his country that they must endure some hardships over the next year as Chinafights with the United States for its place in the 21st century.  His remarks are being rightly perceived as clear signals that the Chinese public is being told to prepare for hardships because of the worsening external environment.

IF America was aligned with Europe and Japan and the other OECD and WTO members for this trade war, I would read the tea leaves differently--but that not is how "America First" train rolls. If we had the #3 - #10 world economies on our side and fully committed to a showdown with China over its asymmetric non-WTO trade policies once and for all, this whole exercise would have much higher chances of win-win conclusion. 

The fact is the market was sold a bill of goods and was wrong assuming the close of the trade agreement advertised as "just weeks away" by the White House and Treasury Secretary. New evidence is in this week that China thought they had the US by the economic short hairs and did what Chinese deal makers always do--they made serious last-minute changes in the structural economics and mercantilism agreements. Mr. Trump didn't anticipate this customary last-minute renegotiation and flipped out (like I have shared before--ANYONE who every negotiated ANYTHING with the Chinese should be expecting this move--it is China Negotiating 101).

So here we are. The Chinese are ready to make another metaphorical "Long March" and the Trump administration has chosen to take on the 2nd most important economy in the world by itself with commercial nuclear warheads.

My hope here is cooler heads prevail. But we are going to take precautions to maintain our 30%+ profit this year in case the positive case does not prevail. Many have talked about the power of "mutually assured destruction" that speaks to coming to a peaceful conclusion to this mess. My fear is since Mr. Trump tells us he does not believe in experts or advisors and trusts his "gut" and his beliefs to make decisions, his provincial nature and Chinese naivete are warning signs for a less-than-optimal outcome--or at least more pain before a workable conclusion is reached. 

My advice: Be smart. Don't panic. We will hope for the best and prepare for the worst. Keep cash on hand for over-reactions and a panic flash crash (or two).