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Why Huawei Arrest is a Major Problem for US-China Relations and the Market

Why Huawei Arrest is a Major Problem for US-China Relations and the Market

Over the weekend while Presidents Donald Trump of the U.S. and Xi Jinping of China were at a dinner meeting working out a ceasefire in the ongoing tariffs battle, the CFO for Huawei Technologies was arrested in Vancouver, Canada.

“We believe this is a clear signal that the trade war is escalating to a new level. Public opinion in China will likely become more negative in respect to the trade war, and potentially against US companies. The government may find it difficult to tell the public that they have offered significant concessions to the U.S.”

Meng Wanzhou, the daughter of the founder of the Chinese telecommunications giant, could face extradition to the United States on potential violations of U.S. sanctions against Iran. The arrest could have massive implications for the future of U.S-Chinese relations, and it is a clear sign the trade war is escalating rather than easing.

The Chinese government is outraged over the arrest, and said Meng broke no U.S. or Canadian laws, demanding Canada “immediately correct the mistake” and release her. The Chinese embassy in Canada also condemned the arrest as a “serious violation of human rights.”

The embassy also said it “will pay close attention to the developments and take every action to resolutely safeguard the legitimate rights and interests of Chinese citizens.”

The fallout further complicates the already tenuous relationship between the U.S. and China just days after the two agreed to hold off on further tariffs while ironing out a new trade agreement over the next 90 days.

News sent the market into a free fall for the second day in a row, with the S&P 500 (-2.1 percent), Dow (-2.3 percent) and Nasdaq (-1.3 percent) all seeing sharp declines by lunchtime on the East Coast.

One of the biggest hurdles in the trade war is Washington’s insistence that China give up its predatory tech theft ways as Beijing presses onward to its “Made in China 2025” goal to become a world leader in robotics, aerospace, clean-energy cars and other tech sectors.

This puts Huawei in a particularly dicey spot because the U.S. considers and it and other smaller Chinese tech companies to be fronts for spying.

Per Yahoo:

“We believe this is a clear signal that the trade war is escalating to a new level,” Deutsche Bank chief China economist Zhiwei Zhang wrote in a note Thursday. “Public opinion in China will likely become more negative in respect to the trade war, and potentially against US companies. The government may find it difficult to tell the public that they have offered significant concessions to the U.S.”

The probability of the U.S. and China reaching a trade deal by March 1 has dropped to 30% from 40%, according to Deutsche Bank’s estimates. “U.S. business interests in China face higher risk than before,” Zhang said.

While Huawei lacks the high profile of the Chinese BAT technology giants Baidu (BIDU), Alibaba (BABA) and Tencent (TCEHY), the company has made strides to push into artificial intelligence, chipmaking and 5G wireless services. UBS notes that Huawei is the biggest optical vendor by far outside the U.S. The company is the second biggest smartphone maker by market share, according to International Data Corporation.

“Huawei has been widely recognized as one of the most successful technology companies in China,” Zhang noted.

The company is also a customer of a panoply of global technology companies, leaving its suppliers vulnerable to lost revenue in the event of fallout following the arrest. Its list of suppliers includes the U.S. companies Broadcomm (AVGO), Qualcomm (QCOM) and Micron Technology (MU), which each carry between 2% and 6% revenue exposure to Huawei, according to Goldman Sachs data. Chinese electronics giant Foxxconn also counts Huawei as a buyer and carries 11% revenue exposure to the company.

Huawei’s competitors including Nokia (NOK), Ericsson, Cisco (CSCO), Juniper (JNPR) and Ciena (CIEN) could stand to benefit in the event of Huawei share loss of the optical component industry, UBS analyst Tejas Venkatesh wrote in a note Thursday. However, “it would likely take time to play out,” he added.

“By order of revenue contribution, the optical component suppliers into Huawei are NeoPhotonics (40%, $117mn); Lumentum (11%, $137mn); Finisar (11%, $145mn); Inphi (14%, $50mn); Oclaro (11%, $60mn); and Acacia (~7%, $25mn). If Huawei loses share, it could be net negative for suppliers with high share in the account,” Venkatesh said. “But they collectively also sell optics to the potential share gainers. For instance, Oclaro was the largest supplier of optics to Nokia last year.”