Taiwan, living in the Dragon’s mouth

The Chinese New Year 2024 will be the year of the Dragon, and will bring authority, prosperity, and good fortune, but for who?

For many other countries, it will be the year of elections, particularly the UK and US. The first key election of 2024 is one that Beijing will be watching very closely, and that is Taiwan on January 13^th. Taiwan’s 2024 presidential election is a three-way contest between William Lai, Hou Yu-ih and Ko Wen-je. Each candidate appears to have a genuine chance to win. However, the latest polling suggests the Democratic Progressive Party (DPP) and current vice president William Lai, which Beijing considers to be a hard line ‘splittist’ from China, is favourite to win. If so, how will China react?

Taiwan is a small island that punches well above its weight and is the centre of the world’s semiconductor industry supply chain. The world produces more than a trillion chips a year, and Taiwan is believed to produce more than half of these. Taiwan’s success in semiconductor chips looks to be down to its incredibly efficient manufacturing plants and the very high yields it achieves in producing ‘wafers.’

Following Russia’s invasion of Ukraine and Beijing’s comments about Taiwan, the US has sought to ramp up its chip manufacturing capability. At the end of 2022, Taiwanese chip manufacturer TSMC announced its intention to invest in a new $40bn chip plant in Arizona. However, plans have been pushed back to 2025 and TSMC’s former Chairman has described the investment as an ‘expensive, wasteful exercise in futility’ as he believes manufacturing chips in the US could be 50% more expensive than in Taiwan.

The US and West are concerned about Taiwan and the huge concentration of high-end chip production that would make the US and world economy hostage to a Chinese invasion. Taiwanese companies see little economic advantage in offshoring production and are doing so reluctantly under political pressure. Taiwan’s ‘silicon shield’ is its chip manufacturing, and its politicians must be hoping that the US will continue to support its democratic society from Chinese aggression.

2024 begins with the Taiwan election, but will end with the US presidential election on November 5th. Some UK diplomats are already alarmed by the prospect of the return of wildcard Donald Trump – who is the current favourite in polls, warning he ‘could throw Ukraine under the bus,’ and pull out of NATO.

What have we been watching?

Markets enjoyed a Santa rally buoyed by hopes of interest rate cuts in 2024 but have started the new year in a more cautious mood. The latest minutes from the US Federal Reserve (Fed) tempered expectations for interest rate cuts in 2024. Mixed US economic data last week didn’t help, although US Treasury Secretary Janet Yellen suggested the economy was seeing a soft landing. Meanwhile, there appears to be a greater risk of the conflict in the Middle East escalating. Economic data from China also remains weak, with Chinese workers seeing the biggest drop in hiring salaries on record.

The conflict in the Middle East showed signs of escalating. The deputy leader of Hamas was assassinated by an Israeli drone strike in Lebanon leading the leader of Hezbollah to say that this will ‘not go unpunished.’ The world’s largest shipping company Maersk, announced it was halting vessels sailing through the Red Sea after yet another Houthi missile attack. Meanwhile, the US, UK and ten other countries have warned Houthi rebels in Yemen they will face consequences if they continue to attack commercial shipping in the Red Sea. However, this could be a real challenge as Saudi Arabia discovered after seven years of war in Yemen fighting the Houthi rebels which are backed by Iran.

What does the escalation of conflict mean for investors? The main risk remains to oil tanker supplies, and that higher oil prices could feed into inflation. This would not be helpful for central banks, which are starting to pivot towards interest rate cuts. For companies, the main uncertainty is around their global supply chains, with higher freight costs and the need to hold greater inventories to maintain customer service levels. Interestingly, last week high street retailer Next issued a positive trading update, but within risk factors for 2024, it noted ‘difficulties with access to the Suez Canal, which if they continue, are likely to cause delays to stock deliveries in the early part of the year’.

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In the UK, PM Rishi Sunak says that he is working on the assumption that he will hold a general election ‘in the second half of this year.’  

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In the US, Fed officials concluded that interest rate cuts are likely in 2024 but that it would be appropriate to maintain a restrictive stance for some time. The minutes of the latest meeting indicated increased optimism about the path of inflation noting ‘clear progress’ but appeared to reign in hopes of an early cut in interest rates by saying rates could remain high for some time. US interest rate futures have a 72% probability of an interest rate cut in March, down from 80% before publication of the Fed minutes. The latest economic data was mixed, as jobs data was stronger than expected while average hourly earnings edged up slightly to 4.1%, but this was slightly countered by weaker than expected activity in the services sector in December.

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Wages offered to Chinese workers in major cities declined by the most on record, underscoring persisting deflationary pressures and sluggish consumer confidence. Average salaries for new hires in 38 of China’s largest cities fell by 1.3% in the final quarter of 2023 – the third consecutive quarter of contraction. Meanwhile, the fall out from China’s property development sector continues, and last week a major Chinese shadow bank filed for bankruptcy on the grounds it was unable to pay its debts.

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Brent oil climbed to $79 as the conflict in the Middle East showed signs of escalating.

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Finally, battle of the giants. Chinese company BYD has moved a step closer to toppling Elon Musk’s Tesla as the world’s biggest selling-manufacturer of electric vehicles. It sold a record 526,000 battery-only vehicles in the final quarter of 2023. By comparison, Tesla sold 485,000 electric cars in the same period. Meanwhile, the trade war between the US and China is ongoing, with the US aiming to keep Chinese components out of EVs sold in the country and China, in turn, banning the export of some heavy rare earth materials used in green technology.

Read Last Week’s Alpha Bites – What’s in store for 2024

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.