EWT - EWT Is Under Quite A Bit Of Pressure

Summary

• EWT is dictated primarily by the situation in the semiconductor industry, which has gone from undersupply to a potential oversupply.
• Moreover, political and strategic concerns over semiconductors are getting in the way of an already unfavourable free market.
• CAPEX burdens could substantially rise for TSMC if the US pressures it to cover its other facilities due to concentration risks in Taiwan.
• This could happen while demand in the markets is dropping, meaning pretty weak IRRs on those projects.
• It's getting complicated here and dependent on decisions that are out of our control and not guided by free market economics. Quite risky.

Published on the Value Lab 10/11/22

The iShares MSCI Taiwan ETF ( EWT ) is a pretty concentrated bet on chips and IT. It's a hard ETF to call because of the substantial uncertainty and geopolitical considerations that are becoming a more pronounced trading factor for Taiwan. Moreover, this interacts with the fact that the debate over a recession globally is substantially over, with Taiwanese customer markets looking grim. We think it is wise to pass on these binary and difficult bets for the indefinite future.

EWT Breakdown

Let's have a look at the top holdings .

Unsurprisingly, we see Taiwan Semiconductor Manufacturing Company ( TSM ), which we refer to as TSMC, very high on the list with a substantial weighting of 21%. In addition to that, exposures are more microelectronics and semiconductor companies, as well as financial companies.

Remarks

Let's get the financial exposure out of the way which is the second largest at 20%. Banking companies and insurance companies in Taiwan could have a better environment. Their monetary policy is somewhat dovish , and they are not pushing rate hikes such that a stronger spread between lending and savings rates can be easily achieved. The reason is that the country is struggling with its correlation to China, whose wallet commands a lot of share for Taiwanese companies, and this is limiting growth forecasts and the ability to drive rate hikes. Their rate hikes have been much less aggressive than other regional economies, and indeed relative to most of the rest of the world. It is more reminiscent of Japan which also cannot afford aggressive hiking.

While financials in the EWT have a little less to offer in a rate-hiking environment, the bigger driver, and indeed the more uncertain component of the EWT is the semiconductor exposures.

There are factors to the downside for the semiconductor industry. Firstly, the commissioning of older fabs to meet semiconductor shortages and, in general, an effort to grow capacity is maybe going to cause a glut in the industry. The collapse of markets like crypto plays a role here as well. I remember the last semiconductor glut a couple of years before COVID-19, it wasn't pretty at all. A glut in semiconductor markets will be bad for the value of Taiwanese exports and the value of the products sold by a lot of EWT members.

That was the supply-side concern. On the demand side , things are not looking good either. The global factors pushing a recession are catching up with tech which was more resilient for a time, and this is going to hurt Taiwan. Chinese lockdowns are also going to be a problem because of the China wallet share.

Finally, there are geopolitical concerns. Firstly, Taiwan could one day get invaded. That event would be very bad, naturally. But even in the current geopolitical environment, there are immediate issues. The US is limiting the ability for US companies to sell chips to China to avoid the Chinese getting access to very valuable technology, in particular for AI and intensive computing. This could interact with other companies' ability to sell to China, and could also spur retaliation which could hurt the global economy and spark further mercantilism and value destruction. Also, with the US being more realistic lately about the chances of a Taiwan invasion, especially as Russia has flouted the implicit expectation of peace, strategic interventions directly into essential players like TSMC, who are at the very leading edge of chip manufacturing, could impact shareholder value . Our concern is that TSMC may be required by US or other Western pressures to CAPEX equally into foreign facilities as Chinese domiciled ones. This extraordinary CAPEX burden will not interact gently with the current demand side in semiconductors and drive down ROIs for TSMC.

The EWT trades at a pretty low PE just below 9x. Risks are being considered, but with the costs of some of these risk factors being annihilating for economic value, we remain concerned with the margin of safety here. A cleaner financials play with better geographical exposure and chance for earnings growth like the iShares U.S. Insurance ETF ( IAK ) trades for a very similar valuation. A pass for now on the basis that the Taiwanese economy looks pressured, and that their financial exposures are not as well-positioned.

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