TWN - EWT: Outlook Hazy Hold For Now

2023-07-17 21:51:54 ET

Summary

• Taiwan's stocks have rallied due to optimism about rising semiconductor demand, but potential setbacks in global electronics demand and geopolitical tensions with China could cause a market pullback.
• Taiwan is a popular investment destination for emerging market investors, being the second largest country in the MSCI Emerging Markets Index, but is unlikely to be upgraded to developed market status soon.
• The majority of the ETF's top holdings are in information technology companies, with 23.3% of assets invested in Taiwan Semiconductor, a high-growth company with strong institutional ownership.

Overview

Stocks in Taiwan have rallied strongly YTD and the long-term outlook for this market still looks favorable. Taiwan is an excellent play on rising semiconductor demand, as it has a strong global market share in this area. Optimism about this demand has led Taiwan equities to rally substantially in 2023. Taiwan has outperformed the S&P 500 by around 4 percentage points YTD, largely because of the global demand for semiconductors.

However, I think it may be best to take a wait and see approach with this market, as any continued setbacks in global electronics demand and/or rising geopolitical tensions with China could result in a pullback in the stock market in Taiwan. In my view, South Korea offers somewhat similar exposure to global electronics demand, with less black swan geopolitical risks. I covered opportunities in South Korea in my last article.

I think this ETF is a good hold, but it could also be better to take advantage of the Taiwan Fund (TWN) on any dips, as an increased discount to NAV would create a solid entry point. Last I covered this ETF was way long back in 2015.

MSCI Status

Taiwan is a popular investment destination for emerging market and global macro focused investors. Taiwan is the second largest country in the MSCI Emerging Markets Index, accounting for over 15% of this index. MSCI has chosen to increase its weighting in several indexes but has not been able to upgrade it to developed market status. Its weight in the MSCI All Worlds Market is still around 1.6%.

Taiwan will not likely be upgraded to developed market status soon. Its weighting in emerging markets could increase if South Korea is upgraded, but MSCI was hesitant to do so in its latest review in 2023. The main appeal of Taiwan's stock market is the country's semiconductor companies, which stepped in to supply the market when demand boomed in 2022 .

Industry Overview

The iShares MSCI Taiwan ETF (EWT) is likely the best vehicle to consider at the moment. The majority of this ETF’s top holdings include information technology companies.

23.3% of the ETF’s assets invested in Taiwan Semiconductor (TSM), a high growth name with strong institutional ownership. Taiwan’s semiconductor market still has solid growth potential through 2031.

This company has been one of the key drivers of the ETF's solid performance in the past three years.

Economic Outlook is Hazy

Taiwan is a significant country in Asia, which stands out based on its higher GDP per capita of more than $30,000 and sophisticated export structure. For years, investing in Taiwan has been an indirect play on China's manufacturing growth, as Taiwan exports the lion's share of its products to China and other Asian countries. Global chip demand in 2022, coupled with supply issues, brought Taiwan into the global spotlight in recent years.

Growth in 2023 will not likely be very strong, as declining tech exports have resulted in an economic slowdown in recent quarters. Taiwan slipped into a recession in Q1 2023, as growth declined by 2.87% YoY .

This is a new trend, as Taiwan’s economy performed very well in 2021-2022 despite the global economic slowdown (4.6% in 2021).

Electronics exports began to weaken in the second half of 2022 and early 2023 due to weakened demand from China, the United States and the European Union. While some analysts have been optimistic about demand coming back online from China in 2023, slower growth in Europe has been a new source of concern. The EU officially slipped into a recession this June , although the region only contracted by 0.1%.

To make matters worse, lower than expected demand from China this June caused Taiwan's exports to drop to a new 14 year low . China's PMI contracted for the third consecutive month and was only 49 in June . Taiwan's stock market would not respond well to subsequent poor growth results from China in H2 2023.

Exports account for around 70% of the country’s GDP , and its top export destinations include the following: Mainland China and Hong Kong ( 40%), ASEAN countries (13%), United States (12%), Europe (9%) and Japan ( 7%). Economic setbacks in the United States and the European Union will have a strong, but relatively limited impact, while growth in Asia will impact Taiwan more.

Risks and Outlook

Taiwan is a critical emerging market that has solid performance despite all of the global economic setbacks in the past three years. South Korea is one benchmark to examine.

South Korea's economy is heavily dependent on China's growth as well, but it also offers more diversified exposure to the EU and United States.

The recent weaker demand from China in June is another reason why it may be better to wait this out for a couple of quarters. China's Q2 2023 GDP was 6.3% YoY , which was slightly below consensus growth of 7.3%. JP Morgan cut its 2023 growth forecast to 5%, from 5.5%.

The Taiwan Fund ((TWN)), a closed end fund, may be more volatile in this environment. It is likely a better idea to accumulate shares of this closed end fund during any pullbacks in the market in 2023. This closed end fund's discount has dropped below 20% on multiple occasions between 2020-2022.

The iShares MSCI Taiwan ETF is likely a safer bet in this environment if you want to maintain exposure, as it will likely experience smaller drawdowns during any potential pullbacks in 2023-2024.

I am waiting for any potential pullbacks later in H2 2023 and will consider other markets in Asia over Taiwan for the time being.

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