How To Protect Your Portfolio As Taiwanese Tensions Rise

How To Protect Your Portfolio As Taiwanese Tensions Rise
Theodora Lee Joseph, CFA

over 1 year ago4 mins

  • Taiwan is the world leader in semiconductor manufacturing, and the US, Europe, and China will take a long time to get anywhere close.

  • A military attack on Taiwan by China could result in material product delays and shortages, global inflationary pressures, and a slowdown in economic growth.

  • You can protect your portfolio by avoiding risky assets like emerging market stocks, and by adding non-Chinese chipmakers, aerospace and defense companies, and cybersecurity firms to your portfolio.

Taiwan is the world leader in semiconductor manufacturing, and the US, Europe, and China will take a long time to get anywhere close.

A military attack on Taiwan by China could result in material product delays and shortages, global inflationary pressures, and a slowdown in economic growth.

You can protect your portfolio by avoiding risky assets like emerging market stocks, and by adding non-Chinese chipmakers, aerospace and defense companies, and cybersecurity firms to your portfolio.

Mentioned in story

China was already worked up when one of America’s highest-ranking government officials visited Taiwan earlier this month, and the news that a group of US lawmakers are set to meet won’t calm things down. So with China threatening to take control of the region by force if necessary, that puts the biggest chipmaking economy in the world – and by extension your portfolio – at risk.

What’s the situation here?

Taiwan may only be the 18th largest economy in the world, but it punches way above its economic standing when it comes to semiconductors. It manufactures 65% of global computer chips, while China and the US – the two biggest consumers of semiconductors – have a combined market share of 15%. Taiwanese chipmaker TSMC alone makes over three times that.

Semiconductor market shares by country

Right now, the world is overly dependent on Taiwan to meet the bulk of its needs for these chips. And while the US, China, and Europe have already promised to invest more than $250 billion between them to build their domestic chipmaking capacity, the learning curve is steep: these new projects probably won’t produce any new chips before 2026. As for the US’s ambition to achieve “complete manufacturing self-sufficiency”, it’ll take at least 10 years and more than $1 trillion in investment, according to Boston Consulting Group and the Semiconductor Industry Association.

What impact would a Chinese takeover of Taiwan have?

1. It would lead to delays and shortages.

If China were to attack Taiwan, one of the most immediate business risks is a new global shortage of chips. While they typically account for a small percentage of total material costs, they’re also irreplaceable. That means a scarcity of chips can halt production altogether.

We’ve seen this play out in the Covid era. To take just one example, Apple had to delay new product launches and cut production targets, which negatively impacted its sales growth. And since Bloomberg estimates that Apple accounts for about 25% of TSMC’s business, this is an example of what could happen on a much bigger scale in the future.

2. It would push up global inflation.

The chart below shows the effect of the pandemic-fueled shortage on chip-dependent industries in the US, which represent about 40% of the country’s manufacturing sector. Prices of goods from chip-dependent industries rose an average 4 percentage points higher (in red) than prices of goods from industries that have no reliance on chips (blue).

Price changes in U.S. manufacturing industries

3. It would drag on global economic growth.

For one thing, China is responsible for a fifth of the world’s total economic output, which means a burden on its economy – from, say, a military conflict – would have far-reaching implications.

And for another, a disruption in Taiwan’s chip production would lead to worldwide production shutdowns and, ultimately, a dent in economic output. After all, TSMC manufactures chips for other chipmakers and chip designers, including Broadcom, Qualcomm, Nvidia, AMD, and Texas Instruments. And since they supply the world’s biggest makers of consumer electronics, communications equipment, and car parts, this would have serious ripple effects.

TSMC's main customers (supply chain)

So how can you protect your portfolio?

Military conflict has been linked with 10-20% declines in a country’s stock market, and it’s been particularly bad for emerging market (EM) stocks. It’s also been associated with inflationary and recessionary risks, so remember to stock up on some portfolio must-haves: low-beta stocks, Treasury Inflation-Protected Securities (TIPS), and niche alternative assets.

You might also want to add aerospace and defense ETFs into the mix: the iShares U.S. Aerospace & Defense ETF (ticker: ITA, 0.39%), Invesco Aerospace & Defense ETF (PPA, 0.61%), and the SPDR S&P Aerospace & Defense ETF (XAR, 0.35%). And since wars are increasingly being fought online, cybersecurity ETFS like the SPDR S&P Kensho Future Security ETF (FITE, 0.45%) could also be a good bet.

If you fancy being a little more direct, you could invest in chip production companies based in the US and Europe, like ASML, GlobalFoundries, Tower Semiconductor, or even South Korea-based Samsung Electronics. All of them are likely to benefit from a reduced supply and higher prices in the event of a disruption, as the world’s manufacturers turn to them to make up for Taiwan’s absence.

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