China and the United States are in a tense situation regarding the technology sector, following recent incidents involving Chinese “weather” balloons and news suggesting that China could militarily assist Russia in its war against Ukraine. At the center of these tensions is a Dutch company, microchip equipment manufacturer ASML, which has been restricted by the U.S. from selling its latest equipment to China, and which has revealed intellectual property theft by China.
Peter Tchir, head of macro strategy at Academy Securities, has pointed out that a potential war over semiconductors could be labeled World War 3.1. Tchir quotes retired Lt. Gen. Robert Walsh as explaining why microchips are so important. Walsh claims that the U.S. wants to prevent China from obtaining the higher-end chips that can be used in advanced military systems during a conflict with the U.S.. For its part, China has made clear that its operational concept for future warfare is the Joint All Domain Command and Control (JADC2) strategy, a concept the Defense Department has developed to connect sensors from all branches of the military into a unified network powered by artificial intelligence.
Walsh has also noted that China aims to be the world leader in artificial intelligence by 2030 and on par with the U.S. military by 2035, and that high-end chips are needed for AI, supercomputing and weapons technology. Tchir divides the current semiconductor space into four: leading edge, which is dominated by Taiwan; high-tech, which is one to three generations behind and where Taiwan is leading but the U.S. is competitive; mid- to low-tech, which is global in nature; and commodity chips.
Tchir points out that there is a real risk that the U.S. will push too hard and block technology that is not as critical, which could cripple U.S. companies’ sales to China. From a trade standpoint, Washington must execute a balancing act. So far, everything seems to be going well, but it is something to watch closely. According to FactSet, 29% of company revenues in the iShares Semiconductor ETF (SOXX) come from China.
Another big risk from the semiconductor perspective is China invading Taiwan or, from their perspective, forcibly annexing a renegade province. That would run the risk that the fabs would be damaged to the point of non-functioning, although the flip side of that is that, in that scenario, the West wouldn’t be able to get those chips either.
What would be the investment implications of the outbreak of World War III? Tchir says in that scenario, he would reduce exposure to China. The iShares China Large-Cap Equity ETF (FXI) and the KraneShares CSI China Internet ETF (KWEB) have been falling lately.
