Semiconductor stocks were hit with a twin punch on Wednesday morning. Bloomberg News reported that the Biden Administration is considering Additional export restrictions on semiconductor technology in China. Since a significant portion of revenue comes from Chinese clients, this could adversely affect earnings in the near future. Tensions were already high after pro-independence forces did well in a Presidential election, and China conducted reciprocating and punishing war games.
The same morning these new restrictions were reported, US Republican Presidential Candidate and former President Donald Trump cast doubt on recent verbal security guarantees granted to Taiwan by President Biden should he become elected to office. Trump said the US "doesn't get anything" from Taiwan, and the US defense umbrella it enjoys is like insurance that it should pay for despite a lack of modern precedent for such an arrangement.
Both these developments caused a selloff in the semiconductor sector, particularly in $ASML,$TSMC, and $NVDA. Taiwan Semiconductor, a Taiwanese corporation, has become the most important semiconductor producer in the world. The reason a company like Nvidia can be valued in the trillions and have a margin near 80% is because TSM figured out a way to enable companies to use their highly expensive semiconductor fabs instead of building their own.
The cost of semiconductor fabs has become so high in recent years that they are prohibitive for virtually any private entity aside from a handful. Call it Moore's Second Law. Costs of fabs and semiconductor production increase as chips shrink. This concentration, particularly in Taiwan, means that global technological progress largely depends on the fabs in Taiwan.
They are not only subject to major risks from Chinese military action but also from power shortages on the island and the potential for major earthquakes. So, the companies are hit with the market discounting a potential impact on earnings from restrictions and the higher potential for Chinese military action as Trump's ambivalence toward Taipei's fate could indicate a higher likelihood that China will engage kinetically to achieve unification.
The first reason not to discount Trump's comments on Taiwan too much is that the United States military is still far superior despite Chinese modernization efforts. War gaming suggests that Chinese military efforts would be doomed to failure. A complex amphibious operation is very easy for the US to disrupt, and the US can do it from anywhere in the world and doesn't necessarily need local assets.
When sophisticated war gaming is conducted, China loses every time because it is not able to overcome the dramatic US military advantage and reach. Given relative combat experience, it would probably be even worse for China in real life than in the game. This is the first reason for not discounting the possibility of Chinese military action in Taiwan; despite Trump's comments, the fundamental military balance between China and the United States hasn't changed.
Xi is having trouble at home and is not in a position to take a reckless military gamble in Taiwan. China hasn't fought a war since the late 1970s against Vietnam, and it didn't go well for them.
The second reason not to discount Trump's comments too much is that earnings are about to start, and the momentum for TSM is very good. The AI revolution is in full swing. Furthermore, one underappreciated deterrent to a Chinese invasion is that TSM has stated that the government will destroy the coveted fabs should the Chinese invade. The Chinese are aware of this.
But the biggest part of the second reason to buy semiconductors like $ASML, $NVDA, and $TSM is the incredible pace of earnings growth they are receiving. They all have strong competitive moats, and demand for their products does not appear to wane. Of course, a war over Taiwan would render their commercial moats much less valuable, but it wouldn't eliminate them. All of these companies have specialized know-how and talent that can't be replicated.
The third reason to not sell based on Trump's words is that right now, I believe many Americans are dramatically overestimating Donald Trump's likelihood of being re-elected. Swing state polls show Trump has an edge, but he is also the most hated Presidential candidate in recent history.
There are major legitimate concerns about Trump and his running mate's foreign policy both inside and outside the party, but I have difficulty believing that Trump's campaign of rust-belt grievance will win over the suburban women that he needs in order to become President of the United States again. Time will tell, but I think Trump will lose largely because I believe turnout attrition from 2020 will affect the GOP far worse than the Dems.
