TS Lombard with the note:
Covid-19 is accelerating the already existing structural shift in demand for integrated circuits
As the world becomes more interconnected, more automated and greener, each unit of GDP growth will contain a higher content of semiconductors
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Growing economic and national security importance, coupled with superpower rivalry, is likely to cause a bifurcation of the current supply chain and eventually chip production in US and China blocs
American defence (reshoring) and offence (tech IP controls) lay the foundations for long term US + allies dominance of semiconductor production
China is ramping up low end chip output, but will remain well behind global leading edge capabilities
In the near to medium term(1-3 years), the winner of the shift in demand, supply chain and geopolitics is East Asia
Covid-19 is accelerating the already existing structural shift in demand for semiconductors. As the world becomes more interconnected, more automated and greener, each unit of GDP growth will contain a higher content of semiconductors. Integrated circuits are becoming the key commodity input for economic activity. The demand shock is triggering huge political tremors as governments acknowledge their dependence on external supplies of the “new oil” and scramble to launch reshoring initiatives. Like oil, chip output is concentrated in a few key geographies that face growing geopolitical risks. The location of advanced semiconductor supply in China’s backyard is a major issue for corporate and military planners.
Growing economic and national security importance, coupled with superpower rivalry, is likely to cause a bifurcation of the current supply chain and eventually chip production in US and China blocs. Washington is driving the change and government reshoring initiatives complement a corporate effort led by Intel, which is making a bid to become the West’s geopolitically secure manufacturer. Meanwhile, the tech war continues. Preventing China gaining the tech know-how to leapfrog ahead in economic dominance and therefore political influence is a priority on both sides of the aisle. US defence (reshoring) and offence (tech IP controls) lay the foundations for long term US + allies dominance of semiconductor production.
Over the next 3-5 years, the winners of the shift in demand, the supply chain and geopolitics will be countries with a physical integrated circuit trade surplus and/or a technical one. East Asia has both, while the US, through its dominance of design tools and inputs into advanced manufacturing equipment, possesses the former. Taiwan and Korea are clear winners and will continue to profit from very strong external demand and an increase in geo-economic power.
China is a semiconductor twin-deficit country, with insufficient domestic production and a dearth of advanced IP. Beijing recognizes this acute vulnerability and has mobilized political and financial capital to support domestic industry. A classic government-led expansion is underway in China. The development model of state subsidized low-end capacity growth, followed by consolidation around a number of national champions, is likely to play out over the next five years. Amid the inevitable misallocation of capital, China will progress up the value chain.
But it is not all good news for East Asia. Taiwan, in particular, is vulnerable to Chinese military pressure, which will continue to rise in response to gains in Taipei’s geo-economic power. We see early signs of “Dutch disease”:Korea and Taiwan’s economic and political fortunes are increasingly tied to the electronic component cycle. Shifts in technology, a breakthrough in Beijing or a misstep by TSMC pose grave threats to Taipei. Taiwanese equities and FX will become even more closely tied to the tech cycle.
The trends explored here will persist through the 2020s; nevertheless, at this stage of the cycle,valuations seem stretched across listed semiconductor stocks. A near-term peak for the first wave of the semi-cycle looks close. A“buy on dips” approach is warranted for leading semiconductor capital equipment providers and firms with clearly unassailable monopolies (TSMC, ASML,etc.). Conversely, we would avoid producers at the lower end of the technology spectrum, which are vulnerable to PRC moves up the value chain, NAND memory is a prime example. On FX, we are structurally bullish KRW and TWDbut cautious near term as the dividend payment season tends to drive outflows.