Concerns are growing that an escalating trade war will hit key global growth engines, such as semiconductors and automotive industries. However, the picture may not be the zero-sum game many imagine. Indeed, the tariff war has already unleashed a host of unintended consequences. The complexity of global supply chains within these industries demand investors are prepared to challenge prevailing consensus to exploit emerging opportunities.
One industry in the eye of the ongoing trade war storm is the semiconductor industry. Our variant perception is semiconductor manufacturers are less likely to be hit by tariffs than the market perceives, but leading-edge semiconductor equipment manufacturers are more likely to face the risk of export bans.
Lost in retaliation
Both the US and China appear to be unable to grasp the complexity of supply chains. From Washington, the appearance is China runs a massive trade surplus with the US in electronics – China exported approximately $200bn of electronics and machinery to the US in 2017. But this does necessarily recognise the evolving supply streams; semiconductors exported from Taiwan, Japan or South Korea into China represent profit that will ultimately go to US companies. Similarly, Beijing sees the imports of semiconductors and fears it is lagging in a growth area of the global economy. Yet those imports drive almost three times as much exports of finished goods and are absorbed into the domestic economy.
Overall, we are less concerned about US manufacturers facing export bans into China – this would be tantamount to ‘cancelling Christmas’, as virtually every advanced gadget requires silicon. Without silicon imports, a lot of China’s electronics industry will come to a standstill. Hence, we do not foresee China placing tariffs on imports of semiconductors in the short term. Indeed, it is important to understand that higher-value semiconductors are rarely easily and rapidly substitutable.
We do think, however, there is a risk the White House will impose tariffs or possible bans on exports of leading-edge semiconductor manufacturing equipment to China. Indeed, there is historical precedence for this. Combine this with increased US assertiveness against Chinese attempts to ‘appropriate’ intellectual property (IP) – particularly in the semiconductor arena. We are coming to the conclusion the actual delivery of working silicon in volume with clean IP by new entrants might be less than anticipated by the market. Hence, we have been positioning the portfolio accordingly – i.e., still holding long positions in computer memory companies and shorting a leading-edge equipment maker.
A fowl warning
Another industry at the epicentre of the tariff disputes has been the automotive industry. It was the leading-edge industry a couple of decades ago, with a lot of political capital dedicated to ensuring car plants were built in the radius of metropolises. However, these days, global car companies often have specific plants building specific models – or ‘platforms’ – for a global audience.
The result of this has been that European manufacturers such as BMW and Mercedes now have plants in the US building their SUV models. Consequently, the European reaction to Trump’s tariffs – with Europe raising tariffs on US exports – has hit German SUV exports from the US to Europe, impacting European companies more than US auto equipment manufacturers.
The real madness of the current tariff structure in the automotive sector is perhaps best illustrated by the 1964 ‘Chicken Tax’, where Ford – the company Chicken Tax was meant to protect – imported the first generation of its Transit Connect van from Turkey with rear seats and seatbelts, only for these items to be removed and shredded in Baltimore and a metal panel put in to replace the rear window. The rationale for all this activity was to avoid the vehicles being classified as ‘light trucks’ – and subject to 25% tariffs – when entering the US.
We anticipate tariffs and trade disputes are going to get increasingly heated, but ultimately businesses will make pragmatic decisions – even if it means shredding more seatbelts and seats. Certain components, which cannot be substituted – whether it be leading-edge silicon or capacitors – are relatively insensitive to demand. Products which have alternatives and are easily substitutable will, however, be hit.
Randeep Grewal, portfolio manager of the Trium Opportunistic Equity fund