During the heated U.S.-China trade war, President Donald Trump clearly appealed to conservative and patriotic hardliners. However, the business community didn’t exactly share the same sentiment. Obviously, going after the world’s second-biggest economy wasn’t exactly great for the bottom line. Still, one exception to this assumed narrative could be Taiwan Semiconductor Manufacturing (NYSE:TSM). Judging from its year-to-date performance, TSM stock is loving the tensions between the two.
First, a quick recap. Last year, Trump escalated simmering tensions with China by going after one of its flagship companies Huawei. As the New York Times reported, the Trump administration released “a rule that restricts government agencies from doing business with Huawei, the giant Chinese maker of telecommunications equipment and smartphones.” However, the measures taken against China had a loophole that didn’t address non-U.S. firms.
Well, earlier this year, the federal government moved to close this loophole. According to TechCrunch.com, “The U.S. Commerce Department released its new orders on Friday, which specifically target Huawei by making it harder for the company to create chips using U.S. software and technology, even in foundries located abroad.” Obviously, that last point is incredibly significant for TSM stock.
From a report by the Nikkei Asian Review, Taiwan Semiconductor stopped taking new orders from Huawei. But to sweeten the pot for TSM stock, on the same day that the Commerce Department announced its new order, TSM disclosed “it is opening a new $12 billion advanced chip foundry in Arizona with support from the state and the U.S. federal government.”
Of course, the Chinese were furious. And it has apparently led the government to explore initiatives with Semiconductor Manufacturing International (OTCMKTS:SMICY) to reduce foreign dependency on semiconductor fabrication. Is TSM stock in danger?
For Now, TSM Stock Is Safe
On the surface, the narrative for TSM stock is unchanged despite recent geopolitical rumblings. As expected, China’s government is pushing for semiconductor self-sufficiency as part of its global ambitions. But planning for something and actually achieving it are two different subjects.
Technically, SMIC is far behind Taiwan Semiconductor and other competitors, like Samsung and Intel (NASDAQ:INTC). Sure, SMIC will be the “fourth company to enter the 10nm-and-lower process market.” Eventually, it could rise to one of the world’s top fabricators.
However, at the moment, SMIC’s best products lag that of Qualcomm (NASDAQ:QCOM). Even regionally, a huge gap exists between SMIC and Taiwan Semiconductor. Since it will take years for SMIC to catch up, TSM stock is safe.
Nevertheless, long-term investors shouldn’t get too comfortable. According to another report from the Nikkei Asian Review, China has hired over 100 TSM engineers to advance the Asian juggernaut’s chip leadership goals. And this report may be more significant than people realize.
Specifically, Beijing’s GDP per capita has narrowed the gap with Taiwan. Back in 2010, Beijing’s GDP per capita was $11,133 (from 2020’s conversion rate of 0.147) while Taiwan was $19,262. That’s a 73% gap. Fast forward to 2019 and the gap has narrowed to less than 3%. Nominally, Taiwan’s GDP per capita was $24,828 while Beijing registered $24,161.
Click to Enlarge
Put another way, Taiwan is Taiwan. But China (through big cities like Beijing) is the future. Clearly, the economic growth narrative favors the Chinese. So, can they continue to brain drain, especially if the global economy wanes? Oh, absolutely!
Indeed, I’d be surprised if the Chinese didn’t engage a full-court press to drain all of Taiwan’s brains. Frankly, money talks and something else walks. And China has much of it, sparing no expense to forward its ambitions.
Enjoy the Outperformance in the Interim
Again, this isn’t a call to hit the panic button. If you compare TSM stock to the sector benchmark VanEck Vectors Semiconductor ETF (NASDAQ:SMH), you’ll note that the former is doing very well. That shouldn’t change this year.
It may not change for several years because of the gulf in class between TSM and China’s chip fabricators. Therefore, you can expect the geopolitical winds to be favorable for Taiwan Semiconductor for a while. But you should be aware that the Chinese are encroaching faster than you would like.
So, here’s how to play this. If you like TSM stock, continue to add to your position. But whatever time it would normally take for SMIC to catch up with TSM and top-shelf semiconductors, “discount” that by some meaningful rate.
Unfortunately, I’m not a semiconductor expert so I can’t tell you what that discount rate realistically is. But China’s brain drain strategy is powerful because Taiwan, as a small island nation, doesn’t have the economic resources to placate its best engineers.
In other words, this is an economic war between China and Taiwan. This is the broader perspective to keep in mind as we wind down 2020.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.
