Why semiconductors have become a geopolitical issue – and what it means for investors

Key points

• The semiconductor sector has been called ‘the new oil’, reflecting its global significance and use as a political tool
• One estimate predicts the chips sector could hit $1trn in revenues by the end of this decade as structural demand drivers underpin growth
• The geopolitical backdrop remains shaky but we remain convinced that technology shifts, policy measures and consumer demand will continue to favour the sector

Often dubbed ‘the new oil’, semiconductors are crucial components of everyday life - from smartphones to fridges, to robotics and advanced industrial systems.

They are also a key part of the technologies seeking to combat climate change, such as electric vehicles and renewable energy. For countries that are at the forefront of semiconductor design and manufacturing, chips are clearly economically important.

However, they are also a global political issue, underscored by recent US moves to restrict exports of advanced semiconductors and advanced manufacturing equipment to China.¹

The global semiconductor market enjoyed sales of $600bn in 2021, with analysis from McKinsey suggesting an annual growth rate of 6% to 8% a year, up to 2030 – meaning a potential $1trn industry by the end of this decade.²

The importance of chips has been underlined by the supply chain shortages witnessed over recent years. Though primarily driven by the COVID-19 pandemic which resulted in factory shutdowns alongside restrictions on shopping and travel, other factors – including winter storms in Texas and hold ups in the Suez Canal in 2021 – also contributed to the recent global semiconductor shortage.³

One estimate puts the resultant lost revenues at more than $500bn worldwide across industries that use chips – with lost automotive sales put at more than $210bn in 2021 alone.⁴

Currently, the US dominates the chip design industry but accounts for just 12% of global semiconductor manufacturing.⁵ Three-quarters of the world’s chip production capacity is concentrated in East Asia, with Taiwan’s TSMC and South Korea’s Samsung among the biggest players, specialising in the most advanced chips.^{6 7}  China has stated its aspirations to significantly grow semiconductor manufacturing capacity over the next decade; however, its ability to source equipment to build these chips could now be hampered by moves by the US to restrict export of these technologies.

A complex ecosystem

Semiconductors earned ‘the new oil’ moniker because of their strategic importance as a vital resource, and the uneven global distribution of design and manufacturing capacity.

But they are a complex ecosystem – from software, to manufacturing of wafers (used as the base for a chip), and other components, up to the factory known as a ‘fab’ that combines the designs and components to manufacture the chip itself.

Countries are increasingly seeking partnerships to bring together key players in this ecosystem – for example the US has proposed a ‘Chip 4’ alliance with South Korea, Japan and Taiwan.^{8 9} Bringing together countries with comparative advantages can strengthen supply chains, but no doubt there are also political allegiances at play.

As geopolitical tensions have heightened, countries not only want to shore up their supply chains against potential logistical disruption, but they also wish to protect their national interests. For example, there are fears that military tensions with China over Taiwan could cut off a proportion of the global supply of chips.

A strategic and geopolitical priority

The US, European Union, China, South Korea and Japan are among those to have announced support for domestic semiconductor sectors over the past few years, as regions and countries jostle to maintain or increase their foothold in the industry.

The 2022 European Chips Act aims to “address semiconductor shortages and strengthen Europe’s technological leadership”, intending to mobilise more than €43bn of public and private investment.¹⁰ China’s Made in China 2025 initiative included chips as a priority, and in 2021, India approved a $10bn incentive plan to attract semiconductor manufacturers to its shores.¹¹

But policy has gone beyond offering incentives to businesses or investing in upskilling workers – and has entered geopolitical territory.

In August, US President Joe Biden signed into law a bill for Creating Helpful Incentives to Produce Semiconductors – or CHIPS. The CHIPS and Science Act 2022 provides $52.7bn of new funding to boost research and manufacturing of semiconductors within the US. It aims to “strengthen American manufacturing, supply chains, and national security” and to help the US “compete in and win the future”.¹² However, the financial support came with a caveat – “that recipients do not build certain facilities in China and other countries of concern”.

This was followed in October by a sweeping set of export controls on advanced semiconductors and parts for semiconductor manufacturing. These new measures required companies to have new licences for exporting certain items to China, including for use in supercomputers - measures that could potentially put China’s chip industry at a significant disadvantage.¹³

And this has implications for the semiconductor sector globally, and for investors in that space.

Short-term uncertainty but longer-term gain?

In the short term, we expect that certain US companies could see a drop in sales, but they have been navigating this environment for some time now – the pre-pandemic US/China trade war had already put in place several restrictions such as a ban on Chinese telecommunications company Huawei from buying chips made with US technology.¹⁴

In the longer term, the restrictions imposed by the US could impact the ability of China to develop cutting-edge semiconductor technologies. This could potentially mean a more favourable competitive environment for semiconductor companies outside of China, for example in the US and Europe. Additional government support such as the European Chips programme is also likely to be beneficial for the industry.

More broadly, we believe growth prospects for the semiconductor sector remain resilient due to the structural growth drivers of the industries they are used in, from robotics to factory automation to electric vehicles.

Taking cars as an example, the average internal combustion engine-propelled car used $500 of semiconductor content in 2021, while electric vehicles (EVs) used around $1,000, a figure that is expected to rise to $1,500 for EVs by 2027.¹⁵

Overall sales of semiconductors in the automobile market should then grow as take-up of electric vehicles increases - as of mid-2022, electric vehicles accounted for 12.4% of the market for cars globally; their penetration is expected to reach around 30% by 2027.¹⁶

Recently, we have seen some weakness in sales of semiconductors used for consumer electronics such as smartphones and personal computers, against a backdrop of high inflation and macroeconomic uncertainty.

At present demand for chips associated with automotive, industrial and data centres appears to have remained robust; however, share prices of semiconductor companies have softened because of an anticipated slowdown across the board.

This pullback has made valuations of some semiconductor stocks look more attractive, in our view, and while the macroeconomic environment is difficult, particularly due to inflation, we expect companies in this space to be able to pass on much of that cost burden to customers.

The ongoing technology shifts impacting the semiconductor market, such as demand driven by electric vehicles and data centres as well as continuing developments in connectivity such as 5G, should continue to underpin growth of this important market.

As politics and technology become increasingly entwined, active investors should pay close attention to the geopolitical backdrop. However, we believe that fundamentally it will be demand – driven by the ongoing digitalisation of the global economy – rather than politics, that will primarily influence the path ahead and drive growth in the semiconductor sector.