The escalating U.S.-China trade war over the past 18 months has created an uncertain macroeconomic
backdrop with both challenges and potential opportunities. We sat down with Charles John, CFA, assistant
portfolio manager on the Ivy Global Growth Fund and Ivy global technology analyst, to discuss the
implications of the trade war on the global technology landscape as well as China’s aggressive pursuit of
more localized technology.
Q: How do you analyze the trade
war and trade more broadly?
John: The main thing we’ve
noticed over the last 18 months
is the escalating level of rhetoric
between the U.S. and China.
Markets fluctuate based on
euphoria about a potential trade
deal or fear because both sides are far apart – as it
appears they are now. As fundamental investors, we
stay aware of macro factors, but our focus is on stocks
we can own over the longer term.
We think the technology sector is front and center
in the trade war, notably semiconductors. One
statistic puts this in perspective: China consumes
50% of global semiconductors produced, but only
manufactures 20-25% of the semiconductor market.
That’s an imbalance the leaders in China want to
solve for the long term. They are aggressively trying
to create their own technology ecosystem, not
just in semiconductors, but in software, artificial
intelligence and other key areas within technology. I
think irrespective of the trade war outcome – whether
it gets solved in the next few months or the next few
quarters – China’s aggressive ambitions in technology
are very clear and likely to be undeterred.
Q: Technology is a huge part of the economy
globally, whether it’s software, services, internetrelated
businesses or hardware. Ultimately, the
semiconductor industry feeds all of these areas.
What business models are appealing to you as a
long-term investor? And what are the implication
of China’s scale, business capabilities and strategic
John: I think we have to take a step back and ask
one question: Why are we seeing this phenomenal
growth in semiconductors and technology? I think it
is because of the confluence of several factors, which
has not happened before:
- Cloud computing allows people to access huge
amounts of storage and computing for little capital
- New algorithms like deep learning and machine
learning have created vast amounts of innovation
in the technology space.
- The significant semiconductor demand for new
devices, such as televisions, smartphones, artificial
intelligence, speakers or health care.
These things together have created significant
innovation that demands semiconductors and
In terms of China’s capability, one fallacy is that
China has small companies trying to imitate U.S.
companies. That may have been true a decade ago but it no longer is accurate. For example, Huawei
Technologies Co., Ltd. is a Chinese company that has
roughly 180,000 employees, more than 80,000 patents,
the top market position in 5G equipment and the largest
share of the smartphone market worldwide. HiSilicon is
another example. This little-known company is owned
by Huawei and creates the majority of the chipset
technology that drives Huawei.
Source: “Fujitsu World Tour 2017: Co-creation with SAP S4HANA,” Fujitsu, March 2017
As we think about the imbalance within China, one
thing China’s leaders want to do is use companies
likes Huawei, HiSilicon, Baidu, Inc., Tencent Holdings
Ltd. and Alibaba Group Holding, Ltd. to create more
localized technology within the country.
Q: What does that mean to an investor in the U.S., even
in your case where you’re focusing on investments in
global growth portfolios?
John: There are two ways to analyze the trade war
and China’s ambitions for the long run. The first is to
consider who benefits from higher silicon intensity and
the second is to invest in companies that have minimal
exposure to the gyrations of the trade war.
When we think of potential beneficiaries of the
trade war, we’re talking about higher semiconductor
usage throughout the world, whether it is televisions,
smartphones or digital devices. This higher silicon
content in “things” can be thought of as rising silicon
intensity, or increasing amounts of silicon.
According to Fujitsu, there has been growth in digital
products from 100 million personal computers in the
1990s to billions of smartphones in the early 2000s to a
forecast of 50 billion connected devices in the Internet
of Things by 2025.
When you have higher silicon intensity and a new player
like China enters the market, by definition China will
have inefficient designs, sub-optimal architectures and
larger chip sizes versus its U.S. peers that have been finetuning
these silicon designs for decades.
In terms of good business models, we think an obvious
beneficiary of this trend is the foundry companies that
help manufacture these different chipsets. There are two
key areas in which we think they benefit: They can gain
from more players in the market that are trying to make silicon chipsets and they are paid based on the size of
these chipsets. Given the inherent inefficient Chinese
designs for now, foundries get paid more in price per
chipset. Essentially, these companies serve as the “arms
suppliers” in the silicon wars.
The other aspect I mentioned is finding companies with
minimal exposure to trade war risk. For example, analog
semiconductor companies have high margins, complex
products, thousands of customers, thousands of unique
products, and they’re hard to replicate and catch for a
new player in the market, such as China.
Q: To recap, the “arms suppliers” are the fabrication
businesses with dominant scale, minimal competition
and benefit from secular growth and continuing
semiconductor consumption. And China as a consumer
and producer is going to drive continued demand.
Separately, the analog space is a classic competitively
advantaged industry structure with a moat that prevents
new entrants. They appear to be value-add vendors that
have a locked-in position, regardless of the trade war.
John: That’s right. An extension of the two premises
that we’ve built around China’s goal of producing more
homegrown technology is that you do not want to
own at-risk companies. Several large-cap technology
companies around the world have been insulated from
new players coming into the market. China has the
intelligence, capital and wherewithal to enter the space
for a long time.
As long-term investors, we seek to avoid at-risk
companies and thus try to avoid exposure to the
downside risk. Overall, I believe companies in the
foundry or analog spaces provide the least exposure to
trade war risk, which may help lessen the downside.
Tech, trade war and China’s chip ambitions
The opinions expressed are those of Ivy Investment Management Company and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are subject to
change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to
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Top 10 holdings of Ivy Global Growth Fund, as a percent of net assets, as of 10/31/2019 include: Airbus SE 5.5%, Amazon.com, Inc. 4.7%, Microsoft Corp. 4.0%, Visa, Inc., Class A 3.7%, Thermo Fisher Scientific, Inc.
2.9%, Ping An Insurance (Group) Co. of China Ltd., H Shares 2.6%, Dollar General Corp. 2.5%, Alimentation Couche-Tard, Inc., Class B 2.5%, Ferrari N.V. 2.5%, Johnson & Johnson 2.4%.
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