Exponential Investor – formerly known as UK Uncensored
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In today’s issue…
- Xi Jinping entrusts the development of China’s chip industry to Liu He
- China and chips dominate emerging markets – from MSCI’s point of view
- What about developed markets?
One of the two main cities on Bulgaria’s sunny Black Sea coast, Varna is a long way from China.
Nevertheless, over my first cappuccino of the morning, I saw three reminders that China is simply too important to ignore.
One of those reminders was a Special Report in The Economist on the 100th anniversary of the founding of the Chinese Communist Party (CCP).
In the introduction to that Special Report, the author James Miles describes the CCP as the “world’s most powerful political party”.
The anniversary has been widely reported elsewhere.
The second reminder, from my Tokyo-based colleague Nick Hubble, was a draft edition of Gold Stock Fortunes, one of Southbank Investment Research’s for-subscription publications.
Nick devoted the edition to discussing how the rising geopolitical power of China could affect investors in listed mining companies.
As the edition has yet to be published, I can’t say any more at this stage: nevertheless, I confidently predict that China will feature a lot more frequently as a topic here in Exponential Investor than it has in the past.
The third reminder came from another colleague, Texas-based Eoin Treacy.
A little while ago, in a video for Exponential Investor Premium, Eoin looked at the Chinese government’s plans to develop globally competitive semi-conductor companies.
Xi Jinping entrusts the development of China’s chip industry to Liu He
As you know, semi-conductors – sometimes called integrated circuits, computer chips or, more simply, chips – are used in more or less everything electronic.
There is simply not enough of them.
As an article in Bloomberg recently noted:
Carmakers from Tokyo to Detroit are slashing production. PlayStations are getting harder to find in stores. Even aluminum producers warn of a potential downturn ahead. All have one thing in common: an abrupt and cascading global shortage of semi-conductors.
The hard numbers are very large: for instance, it is estimated that the world’s automobile makers alone lost $110 billion in revenues in 2021 because of the shortage of chips.
In his video, Eoin looked at a European company called ASML Holding (NASDAQ: ASML), which has a global monopoly in the production of machines which make semi-conductors – or chips.
Like most monopolies, ASML is very profitable – and a lot of people know this.
Its share price having risen from about $400 to $680 over the last year, ASML is trading on a price/earnings (PE) ratio of about 47 times and a price/sales ratio of 15.5 times.
In plain English, this means that the current stock market valuation of ASML is equivalent to 47 years of (current) profits and 15.5 times (current) annual sales.
As Eoin points out, ASML can be choosy about the companies to whom it sells its machines.
For now, about 80% of all chips globally are produced by makers in Taiwan and South Korea.
Leading companies include giants such as Taiwan Semiconductor Manufacturing Co or TSMC, (NYSE: TSM) and Samsung Electronics Co (KRX: 005930). TSMC alone plans to spend $100 billion (yes, billion) on new plant and equipment over the next three years.
China’s government is acutely aware that that country’s makers of everything electronic will need a lot of chips in the future.
Geopolitical tensions between China on one hand and the United States (and other countries) on the other may make it more difficult for Chinese companies to acquire the chips that they need.
The government’s solution is to foster the development of a domestic semi-conductor industry which includes companies that are genuinely competitive in global markets.
This is the mandate that Chinese President Xi Jinping reportedly gave to Vice Premier – and economics expert – Liu He about a fortnight ago.
Eoin notes that, with support from the government, China has already developed globally competitive companies in areas such as solar panels, social media, e-commerce and ride hailing.
For now, he is prepared to give the Chinese government the benefit of the doubt that it can achieve the same outcome in the semi-conductor industry…
… which could have interesting implications for ASML.
China and chips dominate emerging markets – from MSCI’s point of view
Another sign of the global importance of China’s economy and stock markets – and the world’s chip makers – comes from the MSCI Emerging Markets Index.
As I explained in a recent edition of Capital & Conflict, MSCI is a company that compiles and calculates indices which define stock markets around the world.
These indices are widely used by investors as benchmarks to measure investment performance.
MSCI is possibly the best-known arbiter of exactly which countries are included in the Developed Markets, Emerging Markets and Frontier Markets categories.
In classifying a particular country, MSCI looks at the overall economic development of the country in question and how open its stock market (s) is/are to inbound investment by foreigners.
In terms of their economic development, the emerging markets are a lot more varied than the developed countries.
Particular companies are included if they are large enough and sufficiently widely traded to meet MSCI’s standards.
What matters for this edition of Exponential Investor is that China, Taiwan and South Korea accounted for 38%, 14% and 13% respectively of the MSCI Emerging Markets Index at the end of May this year.
TSMC alone accounted for 6% of the index; Samsung Electronics for 4%.
Other leading companies in the index included Chinese stocks Tencent Holdings (HKG: 0700), Alibaba Group (HKG:9988) and Meituan (HKG:3690) – all technology-related in some way.
In other words, before you choose to buy an exchange-traded fund (ETF) that is based on the MSCI Emerging Markets Index, you need to be sure that you are optimistic about the prospects for leading Chinese stocks, as well as for the largest chip makers in Taiwan and South Korea.
What about developed markets?
A more general conclusion would be that identities of the main stocks that are held by an ETF (or indeed any investment fund) are more important than the general name or concept of the ETF.
Take the MSCI World Index, for instance.
This is a very widely used measure of the performance of the world’s developed markets, and is tracked by a number of ETFs.
The largest companies in the MSCI World Index include Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Amazon NASDAQ: AMZN), Alphabet (NASDAQ: GOOGLE), Facebook (NASDAQ: FB) and Tesla (NASDAQ:TSLA). Collectively, they accounted for about 12% of the value of the index at the end of May.
Discussion of the investment merits of ETFs that invest in the MSCI World Index is beyond the scope of this edition of Exponential Investor.
However, the very high valuation of technology-related stocks is something that has been discussed a lot by Southbank Investment Research’s editors over the last few months.
Just yesterday, Will Dahl advised readers of Capital & Conflict to “beware of the bubble” in global stock markets.
We have China (and chips) in Emerging Markets…
… and over-valued and famous technology companies in Developed Markets.
Those are the challenges that are alluded to in the title.
Until next time,
Managing Editor, Southbank Investment Research