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Economic Insights

A decision by the United States to cease business operations with the Chinese telecom giant has widespread market and economic implications. What does it mean for investors?

 

In Brief

  • The U.S. Commerce Department’s decision to restrict U.S. companies from doing business with telecom giant Huawei had an immediate impact on technology companies around the world.
  • The impact on Huawei suppliers is expected to be negative, but competitors may find opportunities to seize market share.
  • A leader in 5G technology, Huawei is facing restrictions in Europe and elsewhere, which could slow deployment of faster broadband for consumers in multiple regions.
  • As the White House implements restrictions against a Chinese tech leader, we consider what this means for U.S. manufacturing and China’s efforts to become tech-independent.

 

In mid-May, the U.S. Commerce Department, citing security concerns, put China-based Huawei Technologies on the Entity List of its Export Administration Regulations, effectively banning U.S. companies from doing business with the telecommunications giant. Several major U.S. technology firms then made moves to accommodate these new regulations. We expect that these developments in the “Tech Cold War,” as some observers have dubbed the escalating U.S.-China dispute, will have a significant impact on Huawei suppliers and competitors, on the deployment of high-speed 5G data networks in select regions, and, longer-term, on global trade.

Global Telecommunications Market at a Glance
To illustrate the interconnectivity of the global telecommunications industry, consider two products: semiconductors and smartphones. Semiconductors, which are key components of microprocessor chips, circuits and transistors, are found in everyday electronics, including smartphones. The global semiconductor market is valued at $450 billion, and the world’s largest semiconductor manufacturers, Intel, Samsung and TSMC, are based in the United States, South Korea and Taiwan, respectively. When it comes to smartphone manufacturers, the largest companies, Samsung, Huawei and Apple, are based in South Korea, China and the United States. Huawei purchases about $25 billion in semiconductors each year, and is expected to make 250 million handsets this year alone. So when the U.S. added Huawei to its trade blacklist, the ripple effect was particularly significant. 

Effects of U.S. Trade Restrictions on Key Sectors
Looking at U.S.-based companies, we believe the semiconductor manufacturers that supply Huawei are expected to see a negative impact. The market’s reaction has been swift, and severe. The Philadelphia Semiconductor Index, which is composed of 30 semiconductor companies, is down 15.8% since May 1 (see Chart 1).

 

Chart 1. A Grim Post-Huawei May for U.S. Semiconductor Stocks
Price change in the Philadelphia Semiconductor Index, May 1, 2019–May 28, 2019

Source: Bloomberg.
The information shown is for illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is not a reliable indicator or a guarantee of future results.

 

Software companies are also expected to see the effects: Huawei phones use Google’s Android operating system. If you consider that Google Play, the source for music and other media on Android-powered phones, is a revenue generator for the company, having fewer Android OS users than expected could pinch the search giant’s bottom line.

Meanwhile, other communications equipment providers—especially major global players such as Cisco, Nokia, and Ericsson—could gain market share from the restrictions against Huawei.

Trade Restrictions and 5G Deployment
The United States isn’t the only country that has taken action against Huawei. While Huawei is a 5G leader in Europe among other telecom companies, the United Kingdom and Denmark, as well as Australia and New Zealand, agreed to restrict the use of Huawei products due to security concerns. 5G, the “fifth generation” cellular network technology enabling broadband access, powers faster and more reliable internet connection speeds on smartphones and other devices. Consumer demand for 5G and the restrictions against Huawei will create an opportunity for some, such as European telecomm equipment companies, while imposing a massive cost on other telecom service companies in the region, such as Vodafone. As for longer-term effects, if Washington were to implement a complete ban on component shipments to Huawei, we believe 5G deployments would slow down in major global markets. Additionally, the carriers currently using Huawei equipment, located in Europe, the Middle East, and Asia, as well as the Asia Pacific region, would have to revise their long-term 5G implementation roadmap.

Potential Next Steps for China and the United States
China currently consumes 25-30% of global semiconductor shipments. China’s longer-term objective, we believe, is to become tech-independent, with its own semiconductor and software production ecosystems. While other smartphone manufacturers in China will likely rally, taking some of the sting out of the Huawei ban, we believe that China will likely retaliate against the U.S. move with tariffs on U.S. goods; the United States will likely then impose levies on additional products from China. A broadening trade war could have significant implications for certain U.S. companies which generate a large percentage of their revenues in China. (Consider, for example, that China is where the majority of Apple products are manufactured.)

Longer term, we think U.S. firms likely will reconsider where to locate their manufacturing bases. Moving out of China would be a decade-long process to execute and also have a massive impact on global trade.

Summing Up: What Trade Restrictions Mean for Investors
While some of Huawei’s suppliers will likely see negative repercussions from trade restrictions, the company’s competitors may seize the opportunity to gain market share, and we believe other smartphone manufacturers in China will rally. Slower 5G deployments means consumers may have to wait a bit longer for faster mobile connectivity, but other telecom equipment companies could benefit as they step in to fill the void left by Huawei. As always, Lord Abbett’s cross-disciplinary team of technology analysts will be monitoring developments to assist our equity and fixed income professionals in their investment decisions.

 

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Investing in international denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets..

The Philadelphia Semiconductor Index, or SOX, is a capitalization-weighted index composed of 30 semiconductor companies. The companies in the Index have primary business operations that involve the design, distribution, manufacture and sale of semiconductors.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided is for general informational purposes only. References to any specific securities, sectors or investment themes are for illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a reliable indicator of future results.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

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