Author: Mr. X
Will it be war? I hope not and I doubt it. Will it change American funding priorities going forward? Definitely. Will it create opportunities for investors? Only for those who can see which way the wind is blowing.
Speaker of the House Nancy Pelosi says she will be going to Taiwan. Unquestionably, President Joe Biden and the United States military never wanted her to go. The war in Ukraine, rising tension in Serbia, the popular unrest against the government in Iraq, and countless other issues mean that the United States has its hands full. However, once you say that you are going to do something, and another power says you shouldn’t, it becomes an issue of credibility.
And credibility is the most dangerous word in international relations.
The need to maintain credibility was at the root of World War I. It’s why the United Kingdom declared war on Germany after it invaded Poland, even though there was little Winston Churchill could actually do to save Polish independence. (And of course, Poland did end up occupied at the end of the war – just by the Soviet Union.) It’s why the United States kept feeding men into Vietnam while Henry Kissinger struggled to find a way the country could make an honorable exit. It’s why Russia is so concerned about Ukraine possibility being in NATO. And it is why both China and the United States are locked in a destructive geopolitical showdown that neither one of them really wanted.
Move fast, keep winning
As of this writing, Chinese warplanes and ships are testing Taiwan’s median line, leading the island’s Defense Ministry to send its own forces to respond to “military threats.” China has called Speaker Pelosi’s visit “reckless” and has vowed “strong and resolute action” against the United States if the visit goes through. China has already imposed new tariffs on Taiwanese goods. When Speaker Pelosi lands in Taiwan, the Chinese government will need to do something, even if it means hurting its own economy. International credibility is more important.
Over the last year, the West is learning the hard way that geopolitical competition trumps globalization and economic self-interest. Russia’s decision to invade Ukraine and China’s willingness to suffer economic pain because they feel national pride is at stake are both irrational from a purely bourgeois, economic point of view. The whole point of globalization is that a network of international trade and diplomatic agreements will render nations somewhat irrelevant, just different marketplaces where the same group of multinational corporations compete to sell their goods. Until recently, it was almost bizarre to speak of something like an “American” company, as firms consider themselves simply part of the global marketplace. Perhaps the highlight of this was when Nike (NKE), after offending the Chinese government in 2021, responded with a massive PR campaign in which CEO John Donahoe said “Nike is a brand that is of China and for China.”
The decision to cut Russia out of the world economy has led to a catastrophe for Western countries, especially in Europe. Cutting China out of the world economy is probably impossible. Whatever actions are done will cause enough harm on their own. The question is which diplomatic bloc can tolerate it – but pain is on the way.
ProShares UltraShort FTSE China 50 (FXP) is part of the RID Model Portfolio. Under recently, it was one of the underperforming stocks. However, it’s up more than 25% over the last month, and will likely increase further as Beijing suffers the economic consequences. Another possible play to short China in the near-term includes Direxion Daily China Bear 3x Shares [YANG]. If we include after-hours gains on Monday night, YANG is up almost 40% going into this morning.
However, the more significant long-term plays are those in critical industries that are likely to receive American funding as Washington tries to slowly decouple from the United States. There are three critical areas.
The first is rare-earth materials. The most obvious play here is MP Materials [MP], another stock in the RID Model Portfolio. MP is unique because it has the only rare-earth materials mining site within North America. One of China’s great geopolitical advantages is that it has control over the overwhelming majority of rare-earth materials, key metals which will be increasingly needed for electric batteries, smart phones, and other high-tech items. “We cannot allow countries like China to use their market position in key raw materials, technologies or products to disrupt our economy or exercise unwanted geopolitical leverage,” Treasury Secretary Janet Yellen said recently. Easy to say, but right now, MP is only game in town.
The second critical field is semiconductors. Kyrsten Sinema (D-AZ) may be threatening Senator Joe Manchin’s place as the maverick within her party, but even she passed the legislation which is expected to provide an astonishing $52 billion in direct grants for American semiconductor manufacturing, as well as providing a tax credit for plants within the United States.
All attention today is on Advanced Micro Devices, Inc. [AMD], which will be reporting earnings after market close. Nvidia Corporation [NVDA] is the most obvious play and may be trading at something of a discount, down almost 39% YTD.
Two other stocks pose an interesting challenge on timing. Taiwan Semiconductor Manufacturing [TSM] is building a plant in the United States and is one of the most important companies in the world in this field. It will benefit massively from the new American legislation. However, it will also suffer from this diplomatic showdown, especially as the Taiwan New Dollar is declining.
Intel [INTC] suffered a cataclysmic decline after a disastrous earnings report. It is currently down more than 25% over the last six months. Yet this too is providing a discount for investors who are willing to look past short-term difficulties and recognize that massive interest the U.S. government has in ensuring the success of this and other companies.
Finally, there are defense contractors. One play in particular looks especially enticing. Raytheon Technologies [RTX] recently beat earnings expectations, even though it disappointed some on revenue. While most high-tech stocks have been suffering a difficult 2022, RTX is actually up by more than 7% YTD. As America pivots away from wars like Afghanistan and more towards great power competition with Russia and China, Raytheon is in a good position for defense contracts.
As an addendum, one might also consider Palantir [PLTR]. The Big Data analytic company is almost unique in that it has taken an explicit pro-American and anti-Chinese line when it comes to its contracting policies. As relations cool between Beijing and Washington, this can only work to PLTR’s benefit.
Is it time to buy right now? In terms of shorting the Chinese economy, time is of the essence and investors should move fast. However, tech stocks and even MP may suffer a short-term decline as the global economy faces the possibility of a recession. Look for a short-term decline in many of these companies but be prepared to move in quickly. As America tries to rebuild its industrial base for the next century and pivot to competing, instead of cooperating, with China, you’ll want to be in at the ground floor.