Chips and Taiwan Are a New Cloud for Tech Earnings

Then Bloomberg Businessweek ran an interview with Donald Trump in which the former president and current Republican nominee raised doubts about whether the U.S. under his administration would defend Taiwan from China unless the island democracy starts paying for U.S. protection. 

The news poured more than a splash of cold water on what has been a red-hot sector. Chip stocks crashed Wednesday following the initial reports and kept falling. The PHLX Semiconductor Index closed Friday with a weekly loss of nearly 9%. The index had been up 40% for the year to date ahead of the damaging reports after having surged 65% this past year—its best annual performance since 2009.   

Semiconductor investors have long been factoring in the growing risk of lost sales to China due to export restrictions. But Trump’s comments about Taiwan add a whole new element of risk: The island is a major hub for manufacturing the world’s most advanced semiconductors and less-advanced but vital ones that go into products such as thermostats, cars and medical devices. 

This isn’t just about Taiwan Semiconductor Manufacturing 2330 -3.20%decrease; red down pointing triangle, the chip-making giant better known as TSMC that produces key processors for companies such as Nvidia NVDA -2.61%decrease; red down pointing triangle, AMD and Apple AAPL 0.06%increase; green up pointing triangle. The island is also home to many other suppliers of key components used in final chip products. During a speech at a conference in Taipei in June, Nvidia Chief Executive Officer Jensen Huang praised Taiwan as “the unsung hero” of the computer industry, showing a slide of more than 100 companies he described as “treasured partners” to the artificial-intelligence chip star. 

Hence, Trump’s comments “threw gasoline on an already raging China restriction issue that had the chip stocks in turmoil already,” independent semiconductor analyst Robert Maire wrote in an email. Whatever the intent behind them, they may have raised the odds of an attempt at forced “reunification” by China by creating doubt about America’s response. 

Military action against Taiwan wouldn’t just hit chip companies but also the many, many businesses that use those chips. It isn’t a small list: Chips sit at the heart of the cloud computing services offered by Microsoft MSFT -0.74%decrease; red down pointing triangle, Google and Amazon AMZN -0.34%decrease; red down pointing triangle as well as the iPhones sold by Apple and the EVs sold by Tesla TSLA -4.02%decrease; red down pointing triangle, whose CEO is now one of Trump’s largest backers. 

Armed conflict between mainland China and Taiwan is hardly a foregone conclusion, even if Trump wins in November. But investors who mostly have been trading on AI hype need to factor a new element of risk into their models—especially since political rhetoric will only grow louder ahead of the election. U.S. policy toward China is a major issue for both parties, and the question of defending Taiwan will very likely arise again. 

This comes as investors are also grappling with how to value the AI opportunity, especially as coming tech-earnings reports will likely continue to feature more AI investments than actual revenue. 

Risks there still aren’t fully baked in. The Nasdaq Composite Index has come down a bit from the record high it hit earlier this month, but is still up 18% for the year, which is more than double the Dow’s return. And the six megacap tech giants—Apple, Microsoft, Nvidia, Amazon, Google-parent Alphabet GOOGL -0.02%decrease; red down pointing triangle and Meta Platforms META 0.20%increase; green up pointing triangle—have added a collective $3.7 trillion in market value in that time. That is an awfully big bet on a sector that no longer has the luxury of staying out of the political fray. 

Write to Dan Gallagher at dan.gallagher@wsj.com