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Semiconductor Stocks are in the Crosshairs of the U.S. - China Tech War

In the on-again-off-again clash with China, it’s impossible to ignore the dependence both countries have on one another through global supply chains and trade. The finer workings of this relationship are enough to dizzy the most educated of economists. And you can’t take any single part of this into consideration without looking at the broader picture.

That’s why Intel Corp.’s recent announcement that it may outsource all of its chip fabrication to Asian partners has to be seen against the backdrop of the United States and China’s increasingly intense techno-rivalry. Both countries want to protect and promote their national technology champions while still selling to each other while securing and strategically decoupling from their complex multinational supply chains.

This is all about which country is going to lead the commanding heights of global technology with implications for economic strength, financial security, cybersecurity, national security, as well as ideology.

One of the areas where China is still relatively behind is in advanced chip technology, which runs across chip design, computer software and equipment.

America’s Semiconductor Dilemma
Semiconductors are crucial, and the most strategically important technology because they are the materials and circuitry needed to produce microchips that are at the heart of everything from smartphones to advanced satellites. You might think of these microchips as the brains inside all advanced technology.

Understanding the microchips’ intricate and fragile supply chains is important for both policymakers and investors. Alex Capri, of the Hinrich Foundation, outlines a typical manufacturing and assembly scenario for a semiconductor chip: from research and development in America, base silicon ingots are cut into wafers in Taiwan or Korea, and finally the microchips are embedded into end products in China.

The challenge for America is that it wants to protect its lead in semiconductor technology while U.S. companies want to continue selling advanced chips to China. Day by day, this makes China a more formidable tech rival across the board.

Many American chip designers, such as Nvidia (NVDA), Micron Technology (MU), Qualcomm (QCOM), Texas Instruments (TXN) and Advanced Micro Devices (AMD), outsource the fabrication of these chips to Taiwan Semiconductor (TSM). With the exception of Intel (INTC), most U.S. chip companies shut or sold their domestic plants years ago.

American semiconductor and related equipment exports to China climbed 22% to a record $9.8 billion in 2019 while chip exports through Hong Kong added an additional $4.7 billion.

Total U.S. technology exports to China are estimated to have been close to $100 billion and companies such as the ones mentioned above receive 35% or more of their annual revenue from China, in one form or another.

Meanwhile, China’s total revenue from technology sales incorporating American technology exceeded $1 trillion in 2019. This includes telecom exports to America and around the world. The controversy around Huawei we have all been following is the perfect microcosm of the U.S.-China high-tech war.

All this is why Intel Corp. is struggling to keep up with the latest production process and technology. To make matters worse, Intel, which makes a majority of its chips in America, is considering outsourcing all of its fabricating overseas. This news reverberated well beyond Silicon Valley, to Washington, D.C.

U.S. semiconductor firms and their lobbyists in Washington emphasize that they allocate around 20% of revenues to research and development in order to maintain their technological lead over competitors in China, Japan, Taiwan, Korea and Europe. So if sales of U.S. advanced chips to China are curtailed or off limits, then revenue for R&D will be cut back and they will lose ground to competitors. This is America’s semiconductor dilemma.

Can the U.S. Revive Domestic Semiconductor Production?
One way to reduce America’s chip-making vulnerability would be to get Samsung or Taiwan Semiconductor to put a cutting edge fabrication plant in the United States. And that’s precisely what Taiwan Semiconductor is considering, as the world’s largest fabricator is exploring building a new $12 billion facility in Arizona.

The plan is to begin construction of this fabrication facility soon and complete it by 2024 though details, final financial arrangements and Taiwan Semiconductor board approval are currently pending.

Taiwan Semiconductor makes semiconductors for major names like Apple (AAPL) and Huawei Technologies mainly from its home base of Taiwan; it also operates plants in Nanjing and Shanghai.

As Asia’s dominating chip fabricator, Taiwan Semiconductor must execute a diplomatic balancing act between its sizable list of American, Chinese, Japanese and European clients.

But don’t count out Intel since it might be able to focus its efforts and gain political support and cash to help it get back into this high stakes, strategically important game. As strategic decoupling accelerates in America, China and around the world, you can expect a bumpy ride in semiconductor stocks before things settle.