By U.S. export restrictions of powerful chips to China hurt now, but should prove bullish long term
It’s understandable why the U.S. felt the need to act swiftly to keep powerful semiconductors out of the hands of the Chinese government. It’s better to make a move from a position of strength before it’s too late. However, as shareholders of chip stocks, it still hurts. As you may recall, Club holding Nvidia (NVDA) was hit particularly hard about 2 1/2 -months ago when the Biden administration restricted exports of the most advanced American-made chips to China for fear they would be co-opted for military use. Deutsche Bank on Monday dove into the U.S.-China semiconductor cold war in a research note, discussing how the industry got to where it is now and what it may mean going further. While reducing our Club chip exposure of late, we kept small positions in Nvidia, Advanced Micro Devices (AMD) and Qualcomm (QCOM) because semiconductors are at the heart of the technology that makes our modern world work. For investors, especially for those with a shorter-term focus, it’s easy to bash the U.S. government’s recent strike against China, which limits sales of chips that exceed certain performance thresholds and bans those with U.S. citizenship from supporting China’s own efforts to develop advanced chips. After all, both nations have thrived in recent years from a symbiotic relationship: the U.S. designs the chip, and a mix of companies located in the U.S. and Taiwan manufacture them, with China as a major buyer. However, from a U.S. first perspective — and arguably one of longer-term investors who understand that sometimes future gains require short-term pain, the decision to act now and not delay any further makes sense. Analysts at Deutsche Bank pointed out that the industry has key choke points, most notably in the highly contentious region of Taiwan, calling out that Taiwan Semiconductor Manufacturing Company, often referred to as TSMC, represents “54% of total semiconductor production and 90% of advanced chip production.” The advanced chips are what we want to focus on as those represent the big risk to the current world order should they fall into the wrong hands. Deutsche Bank offered a little bit more historical context in its note, writing that due to a supply chain shift in the mid-1970s along with domestic underinvestment and increased competition, U.S. semiconductor fabrication, or manufacturing, market share fell from 37% in 1990 to 12% currently. At the same time, China’s share of manufacturing increased from 1% to 15% now, with the country previously setting the goal of being 70% self-sufficient by 2025. As we’ve seen throughout the pandemic, as friendly as the two global economic superpowers may seem on the surface — though maybe not as much lately — the self-interests of both are always going to take priority. As a result, it is simply too risky to allow China to continually gain an increasing controlling position over the semiconductor manufacturing process. To do so would be to put the U.S. at the mercy of its primary challenger on the world stage. U.S. firms such as Nvidia and AMD may dominate in the design of cutting-edge chips, with Deutsche Bank analysts noting that the U.S. holds a 41% “market share of semiconductor manufacturing equipment, and 85% of electronic design automation software.” However, that will do little good if we can’t manufacture off those designs. For this reason, we think that as painful as it may be in the near term, the U.S. isn’t wrong to block advancement in China. By limiting China’s access to leading American technology, the U.S. is effectively making China’s 2025 goal significantly more difficult to achieve, if it’s even possible at this point. After all, it’s no simple task to replicate the kind of equipment produced by U.S. capital equipment makers. Lastly, don’t forget, thanks to the latest restrictions, U.S. citizens risk losing their citizenship should they choose to help China pursue its advanced chip production goals. So, not only is the U.S. limiting what gets exported to China, the government is also taking material steps to block China’s own ability to develop internally. Along with these defensive actions, we are pleased to see more domestic support for the semiconductor industry. On Monday, as reported by Reuters, TSMC founder Morris Chang affirmed that though the plans are not yet finalized, the company “is planning to produce chips with advanced 3-nanometer technology at its new factory in the U.S. state of Arizona.” Given the growing tensions between the U.S. and China, as semiconductors become increasingly more pervasive in our daily lives and national security applications, and the earthquake risk in the region, we think it stands to reason that future investments from TSMC may be focused outside of China’s reach, even if not directly in the United States due to factors such as relatively high labor costs. As the Deutsche Bank analysts rightly call out, “By delaying China’s ability to manufacture high-end chips — as advanced chip development progresses in the U.S. at a rapid pace–China’s computing power will increasingly fall behind.” That’s why we think that while the near-term pain may be acute, bullishness is warranted from a longer-term perspective with the analysts arguing that “in the long-term, assuming weaker competitive pressures from the advanced Chinese semiconductor industry, we expect U.S companies will likely increase their market share.” Bottom line Semiconductors are at the heart of nearly every secular growth trend one can think of, be it cloud computing, autonomous driving, warehouse automation, innovations in sustainable energy, and the tools required to drive advancements in sustainable agriculture. They’re quite literally, the building blocks of what many, including the World Economic Forum , have referred to as the Fourth Industrial Revolution. So, while chip cycles will come and go, having a stake in the industry in your portfolio makes good sense. That’s a key reason why despite trimming our chip positions of late (and exiting Marvell Technology) due to near-term concerns, we simply could not justify walking away from the sector altogether. However, at the moment, the U.S. has the upper hand — and as a result, we think it’s right to act now and take whatever near-term pain in order to better ensure continued industry dominance down the road. (Jim Cramer’s Charitable Trust is long NVDA, AMD and QCOM. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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It’s understandable why the U.S. felt the need to act swiftly to keep powerful semiconductors out of the hands of the Chinese government. It’s better to make a move from a position of strength before it’s too late. However, as shareholders of chip stocks, it still hurts. As you may recall, Club holding Nvidia
