In the first State of the Union address, George Washington wrote “to be prepared for war is one of the most effectual means of preserving peace.”
It’s fair to assume that the first American president probably wasn’t thinking about how to position a global technology stock portfolio to limit risk amid increasingly rancorous exchanges on trade between one of his successors and his Chinese counterpart.
Candidate Donald Trump never hid his view that international trade agreements are bad deals for the U.S., and one of his first acts as president was to pull the country out of the Trans-Pacific Partnership. That was the cue to begin preparing for war.
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So for more than a year, even investors who ordinarily build a portfolio stock by stock based on fundamental, bottom-up analysis, should have had the top-down macro risk on their radar and been preparing accordingly.
Decades-long tailwindsOn the one hand, the mega themes of the internet of things (IoT), cloud computing, mobility and artificial intelligence stand to create a decades-long tailwind for the tech sector as the global economy undergoes a digital transformation. On the other, geopolitical risk created by President Trump’s posturing about trade and intellectual property theft create short-term headwinds, especially for companies with exposure to China.
A main driver of growth at California-based graphics chipmaker Nvidia NVDA, -2.59% is artificial intelligence, and China accounts for a good proportion of that business. Concern over both trade sanctions and a U.S. desire to thwart China’s ambitions for AI dominance, therefore, widen the range of potential outcomes for the company. Similar risks may also adversely impact Nvidia rival Advanced Micro Devices AMD, -3.42% However, from a game theory perspective, why would the U.S. impair its leaders in AI chips by cutting off their China revenue at a time when those companies need to ramp R&D spending to maintain their lead?
Tech investors would be remiss to avoid companies in the supply chain that may be impacted temporarily by restrictions on doing business with China. Semiconductor makers such as Microchip Technology MCHP, -3.05% which produces tiny microprocessors, semiconductor-equipment makers such as Netherlands-based ASML Holding ASML, -2.06% and Lam Research LRCX, -2.37% of the U.S., and Cadence Design Systems CDNS, -1.54% which provides the sophisticated software needed to design chips, should all benefit in the long term from rising demand spurred by the mega themes of the IoT, mobility, cloud computing and AI, even if they take a short-term hit because of trade impasses.
Other tech industries, such as software and internet, are more or less immune to the politics. Cloud software provider Salesforce.com CRM, -1.67% has little exposure to China and is a key player in the burgeoning software as a service (SaaS) space, while Chinese internet names such as Tencent Holdings TCEHY, -2.31% Alibaba Group Holding BABA, -3.34% and Ctrip.com International CTRP, -1.65% have an almost entirely domestic focus and shouldn’t suffer unduly because of a temporary denial of access to U.S. chips for their data centers. Recent selloffs in Chinese Internet stocks — with Alibaba slumping 11% on June 25 and Tencent dropping 9% the same day — appear overdone and may present opportunities for savvy investors with an eye on the long game.
Made in China 2025Trump’s belligerence may, in part, be motivated by a desire to prevent China fulfilling the goals of its Made in China 2025 program, under which it aims to essentially replicate the global semiconductor industry by investing as much as $100 billion in companies and programs that it hopes can match the capabilities of the world’s best chipmakers.
While that may sound like it could create problems for the likes of Intel INTC, -1.83% Samsung Semiconductor, Taiwan Semiconductor Manufacturing TSM, -2.61% and other leading chip manufacturers, attempting to go from effectively zero to a global leader in about a decade in an immensely complicated industry seems well-nigh impossible.
The upshot for investors who have done the necessary advance preparation to limit risk that trade disputes could create is that they should stick with their convictions and take opportunities to buy the dips in well-managed companies with strong long-term growth potential.
Everything else is just noise.
Brad Slingerlend is co-portfolio manager of the Janus Henderson Investors Global Technology Fund.
