Technology transfer: latest front in US-China trade war
Portfolio Manager Denny Fish and the Central Research Team Global Technology Analysts explain the potential investment ramifications of recent U.S. restrictions on certain technology transfers to China and other countries.
5 minute read
- With an eye toward cutting off the most sophisticated chips used for artificial intelligence (AI) from potential military applications, the U.S. announced tighter restrictions on semiconductor exports.
- U.S. tech (and other) companies should expect a response in kind from Chinese authorities, potentially including reduced access to that country’s marketplace.
- While we see increased deglobalization as a headwind for certain industry players, AI remains a powerful secular theme and we expect the market to adjust to a changing trade regime.
In breaking what had become something of a frozen conflict, the U.S. government fired a new salvo in the ongoing U.S.-China trade war by immediately imposing a new license requirement for any future exports of certain Graphical Processing Units (GPUs) to China (including Hong Kong) and Russia. We believe that the impetus behind the policy change is the U.S.’s desire to crack down on China’s ability to access leading-edge computing technology that could potentially be diverted to military use.
We view this development as a notable – yet probably inevitable – escalation in the U.S.-China economic conflict. For years, China has placed high priority on ensuring access to – and eventually supply-chain autonomy for – sophisticated semiconductor technology. For its part, the U.S. is keen to maintain innovative supremacy with respect to chip design and, with a growing sense of concern, to keep these technologies out of the hands of the People’s Liberation Army. Sophisticated GPUs have become the critical lifeblood of the artificial intelligence (AI) race as the revolutionary computing power associated with this technological advancement will have a meaningful impact on both commercial and military sectors. We expect that rising trade barriers – with each sphere pursuing greater control over its semiconductor supply chain and know-how – will accelerate the trend toward deglobalization.
This move is the latest iteration of an ascendent hawkish stance toward China on behalf of American policy makers. Only recently, semiconductor capital equipment makers were informed of new restrictions governing the exporting of the tools needed to fabricate advanced chips.
Awaiting return fire
The Chinese government will not take this escalation lightly. The U.S. should expect a proportionate response, and not just in the most obvious manner (e.g., taking steps to similarly limit U.S. tech companies to the Chinese market). A range of tech (and other) industries should be aware that material components of their trading relationship with China could come under scrutiny by that country’s regulators.
In both economic and geopolitical dustups, events tend to unfold in unforeseen ways once escalation has commenced. Consequently, the best-laid strategies often fail to take into account all contingencies and must be adjusted to an evolving reality. This is why investors should test the resilience of their tech allocations to determine where vulnerabilities lie as these two heretofore linked economies accelerate their decoupling. We believe chip designers and the memory market could be future candidates for toothier U.S. restrictions, also likely through a curtailment of equipment exports.
Where policy meets profits
The investment ramifications of this escalation will likely be felt on both sides of the Pacific. With respect to U.S. chipmakers, Chinese buyers represent a lucrative market, especially the country’s “hyper-scalers” that are investing heavily in AI and thus have tremendous need for cutting-edge chips. Yet, AI is a secular trend that is taking hold in many developed – and developing – economies that are not subject to U.S. restrictions. Consequently, we consider the risk to revenues a moderate headwind for sophisticated chipmakers rather than a thesis changer.
With respect to China, less access to the most complex chips and capital equipment used to fabricate them will almost certainly dampen Chinese tech and Internet companies’ push toward AI. China’s leading tech platforms have been pioneers in leveraging AI in all facets of their business models. We believe a reduced flow of chips will be acutely felt in Chinese hyper-scalers’ cloud initiatives. Over time, it will also likely impede progress for businesses supported by digital advertising, which, in turn, could weigh on those companies’ longer-term growth prospects and forays into global markets.
Assessing the broader semiconductor complex
While the situation has the potential to evolve in a host of unpredictable ways, at present not all aspects of the semiconductor complex are equally affected. And as with most economic and geopolitical developments, where there is risk there is also opportunity. The design and production of complex GPUs is famously difficult, as evidenced by China’s plodding progress in its home-grown initiatives. Still, the curtailment of cutting-edge chips will likely result in the Chinese government doubling down on advancing its own chip industry.
The removal of incremental demand by Chinese GPU buyers could also result in lower near-term revenues for global chip fabricators. Over time, however, this void could be filled by Chinese GPU companies as their capabilities progress. Lastly, we think the analog chip industry is more insulated to these developments as it tends to use lagging technology that should invite less scrutiny from U.S. policymakers.
Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.
Please read the following important information regarding funds related to this article.
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
- If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
- The Fund is focused towards particular industries or investment themes and may be heavily impacted by factors such as changes in government regulation, increased price competition, technological advancements and other adverse events.
- This Fund may have a particularly concentrated portfolio relative to its investment universe or other funds in its sector. An adverse event impacting even a small number of holdings could create significant volatility or losses for the Fund.
- The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share/unit class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.