Where the US-China trade war meets AI hype

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Chips and China

The semiconductor industry is where US stock market euphoria and the US-China trade war meet. Over the past two years, AI hype has boosted U.S. 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 chart because its epic gains would have made it impossible to single out everyone else.)

At the same time, the Biden administration has attempted 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 in October 2023, closing gaps and limiting sales to data centers. Earlier this month, the United States cracked down on more Chinese companies and pushed its allies to become stricter. The market seemed to anticipate the previous announcements with apprehension, only to recover. Here’s a chart of the iShares US Semiconductor ETF, which tracks major US semiconductor stocks, with the announcement period shaded:

Cyclicality has been more important for the sector than Chinese rules. Most chip stocks, except for AI favorites Nvidia and Broadcom, have been down since July as demand began to weaken. Intel and Samsung in particular are in trouble.

Toolmakers – including the big three US players KLA, Lam and Applied Materials, as well as Dutch ASML and Japan’s Tokyo Electron – were at the center of the December regulations. Over the long term, these are incredible stocks to own: high barriers to entry and a long-term tailwind from the siliconization of the economy have proven to be a powerful combination:

Tool makers have not been completely blocked from selling to China. Here is a graph of the percentage of their total revenue coming from China over the past five years:

The United States, the Netherlands and Japan have already stopped the flow of the most advanced equipment, but Chinese demand for more basic tools has been strong. The December ruling, however, blocks all sales from U.S. companies to many of China’s biggest buyers. And thanks to various agreements between the US, Dutch and Japanese governments, the ban will apply to US companies as well as ASML and Tokyo Electron.

This development was widely expected by the industry and by China: the sharp increase in income in 2024 suggests that Chinese companies were buying massively in anticipation of American restrictions.

What will happen to tool manufacturers’ sales as recent rule changes, and perhaps additional rules and tariffs imposed by the Trump administration, take full effect? If cutting-edge chips can’t be made efficiently in China — and so far, they can’t — they will be made elsewhere, and tool makers will ship their tools there. But could the geographic transition be difficult for the tooling industry? Or could the restrictions serve to incubate new competitors in China, costing incumbents market share?

ASML CFO Roger Dassen recently said:

The way we view demand for our tools is not dependent on a specific geographic area. In this case, China. We watch. . . What is the global demand for wafers and whether those wafers are produced in country X or country Y, ultimately it doesn’t matter. . . It is the global demand for platelets that motivates our modeling

Lam Research CFO Douglas Bettinger sounded a similar note at a recent industry conference:

The US government has restricted the most advanced products, at least from US companies, our ability to sell, you can’t sell the most advanced products (to China). China is therefore investing in the high-tech sector. . . .

In fact, investments (in China) this year have been quite strong. The trend is downward throughout the year. And as we look ahead to next year, we suggested that the trend would be a little bit lower, even beyond that of the December quarter. But it’s not going to go away. I want to be very clear about this.

The recent bans “have not destroyed demand, but have changed the composition of demand,” said Gregory Allen, director of the Wadhwani AI Center at the Center for Strategic and International Studies.

Cantor Fitzgerald’s CJ Muse is more skeptical. He believes excluding China represents a significant loss of revenue for tool makers, and one that they may not be able to recover. “As a result, China will build its own equipment industry. . . China will further expand its business in China, which will lead to loss of market share for all global companies,” he said.

Since this summer, the combination of the cyclical collapse and trade war fears has brought the valuations of U.S. tool makers, which had been trading at a large premium to the market, back to the small discount at which they usually trade .

If you agree with Dassen, Allen and Bettinger that trade wars do not pose a substantial threat to demand or market share, stocks are quite attractive.

(Reiter and Armstrong)

A good read

A man of contradictions.