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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Good morning. Germany is heading for early elections after Chancellor Olaf Scholz lost a vote of confidence. The market was prepared: Germany’s main stock index, the Dax, barely moved and Bund yields were steady. It has been a wild year for democracy. Let’s hope things calm down over the holidays (looking at you, Brazil). Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.
Chips ‘n’ China
The semiconductor industry is the place where the euphoric US stock market and America’s trade war with China meet. For the past two years, AI hype has supercharged American semi stocks, including chipmakers Nvidia, AMD, Broadcom and Micron, as well as makers of chipmaking tools such as Lam Research, Applied Materials and KLA.
(Nvidia is not included in this graph because its epic gains would have made everyone else’s impossible to distinguish.)
At the same time, the Biden administration has tried to limit the sale of chips and chipmaking tools to China. In October 2022, Washington banned the export of the most advanced chips and manufacturing equipment to Chinese companies with government ties. It followed up in October 2023, closing loopholes and restricting sales to data centres. Earlier this month, the US cracked down on more Chinese companies and pushed US allies to get more strict. The market appeared to anticipate the earlier announcements with trepidation, only to recover. Here is a graph of the the iShares US Semiconductor ETF, which tracks the major US semi stocks, with the period of the announcements shaded:
Cyclicality has been more important to the sector than the China rules. Most chip stocks, except AI favourites Nvidia and Broadcom, have been down since July, as demand has started to waver. Intel and Samsung in particular are struggling.
The toolmakers — including the three big US players KLA, Lam and Applied Materials, as well as Dutch ASML and Japanese Tokyo Electron — were at the centre of the December regulations. Over the long term, these have been incredible stocks to own: major barriers to entry and a secular tailwind from the silicon-isation of the economy have proven to be a powerful combination:
The toolmakers have not been completely barred from selling to China. Here is a chart of the percentage of their total revenues that came from China over the past five years:
The US, Netherlands, and Japan have already stopped the flow of the most advanced equipment, but there has been plenty of Chinese demand for more basic tools. December’s ruling, however, blocks all sales by US companies to many of the biggest Chinese buyers. And through various agreements between the US, Dutch and Japanese governments, the ban will apply to the US companies as well as ASML and Tokyo Electron.
This was largely expected by the industry, and by China — the big jump in revenue in 2024 suggests Chinese companies were buying heavily in anticipation of US restrictions.
What will happen to the tool companies’ sales as the recent rule changes, and perhaps additional rules and tariffs brought to bear by the Trump administration, come into full effect? If cutting-edge chips cannot be made efficiently in China — and so far they can’t — they will be made somewhere else, and the toolmakers will ship tools there. But might the geographic transition be difficult for the tool industry? Or might restrictions serve to incubate new competitors within China, costing the incumbents market share?
The chief financial officer of ASML, Roger Dassen, recently said:
The way we look at the demand for our tools is not from a specific geography. In this case, China. We look . . . at what is the global demand for wafers and whether those wafers are being produced in country X or country Y, at the end of the day, it doesn’t matter . . . It is the global demand for wafers that drives our modelling
The CFO of Lam Research, Douglas Bettinger, struck a similar note at a recent industry conference:
The US government has restricted the most leading-edge stuff, at least from US companies, our ability to sell, you can’t sell the most leading stuff [to China]. And so [China is] investing in the trailing edge. . . .
Investment [in China] this year was pretty very strong, in fact. It’s trended down through the year. And as we look into next year, we’ve suggested it’s going to trend a little bit lower even beyond where it is in the December quarter. It’s not going away, though. I want to be very clear about that.
The recent bans “did not destroy demand, but did change the composition of demand”, said Gregory Allen, director of the Wadhwani AI Center at the Center for Strategic and International Studies.
CJ Muse at Cantor Fitzgerald is more sceptical. He thinks that cutting out China is a big revenue hit for the toolmakers, and one they may not get back. “China will build their own equipment industry as a result . . . .China will put more business in China, and there will be a share loss to all global companies,” he said.
Since this summer, a combination of the cyclical swoon and fears about the trade war have driven the valuations of the US toolmakers, which had been trading at a big premium relative to the market, back to the small discount where they usually trade.
If you agree with Dassen, Allen and Bettinger that the trade wars are not a substantial threat to demand or market share, the stocks are quite appealing.
(Reiter and Armstrong)
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