In early October, the US Department of Commerce issued an update around the market’s export controls, announcing a ban across the sale of high-end semiconductor chips, tools and other components, to China. Citing concerns that the technology may be used for military purposes, the restrictions prevent US individuals from supporting chip development or production at Chinese facilities without first receiving an export licence exemption.
The announcement adds to the litany of headwinds faced by Asian technology companies who are already having to reevaluate their capital expenditure plans. Korea-listed SK Hynix, a semiconductor manufacturer that was granted a one-year waiver on the new ban, announced it would scale back production by more than 50%. Meanwhile, Taiwan Semiconductor Manufacturing Company (TSMC), a $450 billion market cap tech company that also received a one-year reprieve from the US Department of Commerce, has indicated that although it is too early to assess the full impact of the restrictions on its business, it will also make related capex cuts.
Asia’s semiconductor outlook remains challenging, according to analyst discussions at Credit Suisse’s Asian Technology Conference in Q3. The US Chip ban is expected to further test valuations for tech stocks, which account for nearly a fifth of regional indices exposure. In fact, gross exposure constitutes as much as a third when adding back Chinese tech giants, Tencent and Alibaba, which are classified as consumer staples and consumer discretionary stocks, respectively. Both SK Hynix and TSMC are also index constituents, with the latter currently the largest member of the MSCI Asia Ex Japan benchmark.
The US chip ban further instigates the uncertainty encountered by money managers when deploying capital and allocating portfolio exposure to the tech sector. Besides semiconductors, internet and consumer related technology equities have come under pressure as the industry confronts ongoing regulatory uncertainty and rising operating costs.
“Companies have been making changes in their businesses to adapt to the new environment, including downsizing the workforce and cutting off unprofitable ventures,” Jin Zhang, portfolio manager and senior research analyst at Vontobel Asset Management, told FinanceAsia.
“Investors should be careful to look at the upstream and downstream of any business for supply chain continuity, as the list of sanctioned entities will only get longer,” he continued.
Indeed, the drop in technology stock valuations has weighed on regional markets, with the MSCI Asia Ex Japan Index down a fifth by early December, unperforming against global market peers on year-to-date returns.
Immediate reaction
Since most imported semiconductor chips headed to China and Asia are installed into mature consumer products such as personal computers, smart phones, and tablets, the export's immediate impact is limited, according to analysts. The larger issue arises later, when demand for more advanced technology grows, which is likely to hold larger political implications and further cloud the industry’s outlook.
China’s policymakers have been vocal in promoting core technologies, explained Robin Parbrook, co-head of Asian Equity Alternative Investments at Schroders, in a note distributed to media. He interpreted the key message of the government’s 20th Party Congress in October, to be around security and self-sufficiency, with Beijing reiterating its commitment to strategic industries such as semiconductors.
Analysts say that a gap between what China can produce and what it desires to achieve still exists, noting that any ban on advanced foundries made in Taiwan and Korea would hinder Beijing’s digital infrastructure initiatives, such as upgrading the market’s 5G connections and its ambitions relating to the internet-of-things (IoT).
The US Chip Act comes amid a backdrop of weaker global growth, where rising inflation is pushing global borrowing costs higher and is further aggregated by supply chain complexities. In a research note distributed to clients, Jefferies global equity strategist, Sean Darby, shared his perspective that it would be naïve to think that the chip ban only ringfences technology companies, given the rising digital innovation push that is taking place globally.
However, he sees the more traditional sectors as further aggravating a market slowdown should they sideline next generation investments such as those deep learning and artificial intelligence (AI) projects intended to elevate their competitiveness. At the end of October, Ford Motors shut down Argo AI, its self-driving startup.
Changes occur as many emerging markets are moving towards services-driven, consumption-based economies with a focus on high tech and consumer discretionary sectors, said Ramiz Chelat, Portfolio Manager, of Vontobel Asset Management. Twenty years ago, the largest constituents of most indices were companies operating in the heavy industries such as commodities and energy. Today, the composition of the emerging market index has transformed into one with a bias towards financials, consumer stocks, and technology, he explained in a research note.
Chinese technology companies continue to grapple with regulatory uncertainty, raising the risk premium that investors assign to the sector. From lingering compliance issues regarding the management of personal user data, to potential auditing restrictions and a subsequent delisting threat for US-traded Chinese companies, a hesitancy builds around allocating new capital – even amid depressed valuations.
For a sector that accounts for nearly a third of regional indices, Asia-based investors will be challenged to retain underweight exposure in an industry that traditionally is synonymous with growth, which is particularly frustrating given that the underlying technology itself continues to advance.
