Stocks were lower on Friday as reports of tensions between the U.S. and China have flared up again. Many economists and market-watchers are concerned that reigniting a trade war during a period of economic contraction and uncertainty is reminiscent of the tariffs that exacerbated the Great Depression. Others believe that these actions are necessary and worth pursuing despite the short-term costs.
Phase 1 Trade Deal
President Donald Trump's trade war began in earnest sometime in late-2017 and continued until the end of 2018 when both sides pledged that they would reach an agreement. Negotiations continued throughout 2019, and a phase 1 deal was struck in 2020 that involved the loosening of some tariffs and pledges by China for purchases of US products.
There was criticism at that time that the deal lacked firm enforcement mechanisms and the deal was more about PR and placating markets than actually solving fundamental issues. Some of these concerns seem legitimate as agricultural prices have remained depressed which wouldn't be the case if China was increasing purchases. Additionally, Chinese imports from the U.S. were 4% lower in the first three months of 2020 compared to 2019.
Period of Harmony
Nevertheless, the early months of 2020 marked a period of harmony between the two countries as there were hopes of a phase 2 agreement being reached which would open up Chinese markets to American businesses, greater intellectual property protections, and complete lifting of all tariffs between the two countries.
Notably, during this period, President Trump was largely complimentary toward Premier Xi and China's handling of the coronavirus. It was expected that along with the economy and strong stock market, the administration's China trade packages would form the centerpiece of his reelection campaign.
Recent Developments
Of course, the coronavirus pandemic has upended this pitch. Instead, the Administration has pivoted to blaming China for the virus which has reignited tensions between the two countries. In recent days, it's intensified even more as President Trump said in a Fox News interview that he has no interest in talking to President Xi, and it could be necessary to completely cut ties.
The latest escalation came Friday morning as the Commerce Department blocked semiconductor (Nasdaq: SMH) sales to Huawei. The move bans any company which uses American software and technology from selling its products to Huawei without first getting a license. Huawei is one of the world's largest supplier of telecommunications equipment and has been mired in controversy due to its ties with the Chinese government.
Following the announcement, the semiconductor index was down 3.2%. Taiwan Semiconductor Manufacturing (Nasdaq: TSM), which is the largest supplier of chip and chip designs, was down 5%. Hu Xijin, who is the editor-in-chief of the Global Times and is considered to represent Chinese government views, said that the move could result in retaliation by China to investigate U.S. companies operating in China like Apple (Nasdaq: AAPL), Qualcomm (Nasdaq: QCOM), Cisco (Nasdaq: CSCO), and the suspension of Boeing (NYSE: BA) plane purchases.
Conclusion
One major catalyst for the strong market rally in 2019 was the improvement in relations between the U.S. and China which removed the tail risk of a trade war between the two largest economies in the world. A reemergence of this tail risk could result in renewed selling pressure for equities.