The digital ink was barely dry on “Suddenly, There’s Not A Lot To Like“, when yet another potentially momentous piece of trade war news hit the wires.
I put the finishing touches on that linked post around 8:00 PM Tuesday – just in time to catch a cotton candy sunset over the water off the back deck.
There’s no rest for the weary, though. The curse of a macro immersion (some would call it an obsession) is that you never know enough. The curse of living in isolation and operating on your own schedule is that there’s no excuse not to find out more.
When Treasury futures blipped higher and S&P futures slipped around 8:30 on Tuesday evening, a quick check of the Bloomberg headlines suggested a New York Times article about a potential blacklisting of Chinese surveillance giant Hikvision was raising some eyebrows. The ocean beckoned, as it’s wont to do, but the irascible German Shepherd who lives one beachside community down, and her equally irascible owner, were out for their nightly stroll and that was all the excuse I needed to forgo a sandy jaunt in favor of digging into the Hikvision story (I don’t care for that dog and I care even less for her owner).
Like many of you, I’d heard of Hikvision in the context of China’s domestic surveillance efforts, which some liken to the buildout of a police state. But also like many of you, I quickly realized I didn’t know enough, especially given that, according to the Times, the company is on the verge of suffering the same fate as Huawei. If that turns out to be the case, it means relations between Washington and Beijing may be about to deteriorate further still.
As it turns out, the Hikvision story is indeed a big deal. I spent about an hour cobbling something together for my site and it was time well spent. According to Times’s sources, the Trump administration intends to blacklist the company in the same way the US effectively banned Huawei, only with a slight twist: The blackballing of Hikvision will reportedly be based, at least in part, on human rights concerns tied to China’s repressive stance toward the Uighurs.
Obviously, this isn’t the platform for debating human rights, but the critical thing for investors to note, is that if the US moves ahead with a plan to cut off Hikvision from obtaining US components and bases the decision at least in part on an ostensible concern for the plight of the Uighurs, the Trump administration will have branded Beijing a national security threat and a human rights violator all in the space of three weeks.
To be sure, those derisive labels aren’t entirely new to China, and the ZTE ordeal means there’s some precedent, but throwing the weight of the US Commerce Department behind allegations as serious as those which form the basis of the Huawei ban and will reportedly be used to justify possible action against Hikvision, is no trivial matter. For markets, it means that a near-term resolution to the trade dispute is seemingly out of the question.
On Wednesday morning, Bloomberg reported that it’s not just Hikvision. Trump is reportedly weighing similar measures against the company’s smaller Chinese “competitor” (if that’s the right word in this context) Dahua. Both companies’ shares were already on the back foot (i.e., down markedly over the past six or so weeks), and Wednesday saw each shed an additional ~6%.
I’m not sure how interested in the details readers on this platform are, so I won’t delve too deeply into company-specific ramifications, but suffice to say that while the US accounts for a very small percentage of the Hikvision’s revenue (roughly 5%), adding Europe and Australia takes the figure closer to 50% of overseas sales (10-15% of total). According to Goldman’s sensitivity analysis “every 50% increase / decrease of overseas revenues could result in a 14% increase / decrease” in Hikvision 2020E net income (and that refers to Goldman’s projections for the company’s net income for next year). The bank also notes that “chipset could be a major bottleneck if US companies were to stop supplying to Hikvision, including Nvidia, Intel / Movidius, and Ambarella.”
There’s more (including some visuals) here, but for our purposes, the point is simply to say that this has the potential to be material for the company. I should note that on Wednesday, Hikvision said it had received no notifications and contends that any “gaps” which might theoretically arise from the stoppage of US component supplies can be bridged.
While a bid to blackball Chinese surveillance companies (and, according to reports, Hikvision and Dahua are two out of five that may be targeted) doesn’t pose the same kind of risks to the global technology supply chain as the Huawei bombshell, it does raise serious questions about how far the US is willing to go in terms of crippling Beijing’s global ambitions. China is all set to sell surveillance systems to foreign governments and now we have the Trump administration allegedly on the cusp of effectively calling that equipment contraband. I don’t know about anybody else, but that doesn’t sound, to me, like something that’s going to go over particularly well with President Xi, especially not if the US mentions Xinjiang in any official communications around an eventual blacklisting.
Markets took this latest dour-sounding macro news in stride on Wednesday – sort of. There was a palpable sense of angst lingering over things and shallow losses on the benchmarks meant that through Wednesday afternoon, this is on track to be the third weekly loss for US equities (SPY) in a row.
Traders were waiting on the Fed minutes, but I’m not sure why. The account of the May meeting was obviously stale because it took place prior to the latest escalations on the trade front. I don’t want to suggest there was nothing worth noting in the minutes (there was, especially the bits about the debate over the composition of the balance sheet and some further color around the “transitory” characterization of the factors weighing on inflation), but the following quote tells you all you need to know about the extent to which the macro assessment is hopefully antiquated:
A number of participants observed that some of the risks and uncertainties that had surrounded their outlooks earlier in the year had moderated, including those related to the global economic outlook, Brexit, and trade negotiations.
Since the May meeting, Brexit has gone off the rails again, the global economic outlook has, if anything, deteriorated slightly (see the April activity data out of China, for instance) and the trade negotiations went from “deal is all but sealed” to “deal is off and no talks are scheduled”.
So, what’s keeping the bottom from falling out completely for US shares? Well, Nomura’s Charlie McElligott cited a number of contributing factors in a Wednesday note, the gist of which is that with VIX roll-down strategies now back in a position to sell vol. (term structure back in contango) and systematic vol. sellers back in the game (i.e., put underwriters), there’s scope for volatility to be suppressed, absent some kind of severe shock. Also, there’s a bit of “right-tail risk” in play as CTAs aren’t far from re-leveraging levels and risk parity equity exposure is low (read: they have room to add to equity longs). Finally, Charlie notes that dealers’ gamma profile is back to neutral, so hedging dynamics won’t necessarily lead to sloppy price action.
All of that argues for a kind of sideways, choppy trade as a rapidly deteriorating macro backdrop fights with upside flow catalysts and vol. selling for control. For a while, that could end in a stalemate.
Meanwhile, BofA sounded a particularly downbeat note in a new rates strategy piece that got some air play on Wednesday. Specifically, the bank threw in the towel on their year-end yield forecasts. The cuts are dramatic: The bank now sees US 10-year yields at 2.60% at year-end versus 3.00% previously and bund yields at -10bp versus +30bp before.
Here are a couple of excerpts:
Following the latest tariff developments, our yield forecasts imply a best case scenario for a resolution of the US-China trade dispute, which seems unrealistic. We cut our forecasts across the board. It would be simplistic to blame these forecast revisions purely on the latest chapter in the trade war saga. Central banks globally have shifted to a dramatically more dovish tone. And inflation has continued to disappoint – surprisingly so in the US, and sufficiently in the Euro Area to finally appear on the ECB’s radar screen. Finally, Brexit and related uncertainty remains unresolved.
The title of the bank’s note: “Marking to misery”.
In light of all the above, I think it’s entirely fair to say that if you’re investing at the asset class level and/or investing based on macro considerations, it would be prudent to keep a close eye on how all of this plays out over the next couple of weeks. Put differently: Make like a Hikvision camera and be vigilant in your surveillance.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.