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How China Could Retaliate Huawei Ban & Its Impact on ETFs

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With no deal, the US-Sino trade relation has rather worsened this May. Just a few days after the Trump administration lifted tariffs on $200 billion worth of Chinese goods from 10% to 25% on May 10, China announced a retaliatory move – a tariff hike on $60 billion of American goods to 25% starting Jun 1(read: Full-Blown Trade Spat: 5 Most-Vulnerable Sector ETFs & Stocks).

President Donald Trump is also considering additional tariffs on an incremental $325 billion of Chinese imports. He signed an executive order per which China will be barred from buying American parts and components to manufacture new products without license approvals.

If this was not enough, per sources, Huawei’s new devices will be denied access to Google's security updates and technical support. Though Washington has temporarily eased restrictions on Huawei, China could use the following tools to fight against the U.S. ban.

Yuan Devaluation

Per a multi-asset investment manager, “currency is the most effective lever to offset the impact of tariffs,” as quoted on CNBC. If the yuan drops about 8%, U.S. companies would have to experience only a 2% jump in importing Chinese goods. This is because a lower yuan would reduce the cost of imports to U.S. companies and any add-on tariffs on the price tags would keep the after-duty price almost at the level where it is now.

In fact, the world has started speculating that China might be considering a deliberate devaluation in yuan. WisdomTree Chinese Yuan Strategy ETF has been down 2.9% in the past one month (as of May 17, 2019) (read: Guide to China Yuan ETF Investing).

Hitting U.S.-Based Companies Hard; Apple is at Stake

Per an article published on CNBC, some U.S. sectors have the highest revenue exposure to China and are thus more susceptible to the trade war. These sectors are the likes of semiconductor, energy, auto and tech hardware and equipment.

For example, the Huawei ban has already dealt a blow to several U.S. semiconductor companies with significant revenue exposure to Huawei. The list includes Neophotonics (47% revenue exposure to Huawei), Qorvo (QRVO - Free Report) (11% focus), Lumentum (LITE - Free Report) (11%), Intel (INTC - Free Report) and Xilinx Inc . So, semiconductor ETFs like iShares PHLX Semiconductor ETF (SOXX - Free Report) are under pressure (read: Will Semiconductor ETFs Survive the Huawei Ban?).

Now, if China decides to retaliate, it might target Apple, which depends on China to get most of its iPhones manufactured. Almost 20% of Apple’s revenues originated from China, where sales are slowing.Chinese consumers are probably shifting to the local version of iPhones, per an HSBC analyst. Probably due to China’s overall economic slowdown and consumers’ inclination for cheaper alternatives, sales of iPhones in China declined in 2018 and the first quarter of 2019.

Morgan Stanley analyst Katy Huberty estimates that a 25% tariff on the iPhone could result in a price increase of $160 for iPhone XS. Or Apple could swallow the tax and not raise prices, which could cause a 23% decline in earnings per share in 2020.

And forget price hike, Apple already offered steep price discounts in China in March and April to boost sales. Market watchers are expecting those discounts to be permanent in the near future.

ETFs which have considerable exposure to Apple may thus underperform. These funds include iShares U.S. Technology ETF (IYW - Free Report) , Select Sector SPDR Technology ETF (XLK - Free Report) and Vanguard Information Technology ETF (VGT - Free Report) (see all Technology ETFs here).

Targeting the U.S. Treasury Market

China is one of the biggest holders of U.S. Treasuries, possessing about $1 trillion of bonds in 2017, according to the Federal Reserve. But China sold the maximum U.S. Treasuries in almost two-and-a-half years in March amid uncertainty about a trade deal between Beijing and Washington, data from the U.S. Treasury Department released, as quoted on Reuters. The Asian giant sold $20.45 billion in Treasuries in March, the maximum since October 2016, after a $1.08 billion in purchases the month before.

If the trend continues. U.S. Treasury yields may rise, resulting in a drop-in bond prices. iShares 20+ Year Treasury Bond ETF (TLT - Free Report) will come under pressure in such a situation. Higher treasury yields would make new debt issuances for the U.S. government costlier. Plus, foreigners started selling off Treasuries in March as U.S. 10-year yields dropped to 15-month lows amid a dovish Fed stance.

However, chances of prolonged damage in U.S. Treasuries are less likely as it is hard to find any other safer alternative other than dollar right now.

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