Is Taiwan risk underpriced? Investor's perspective on China's escalation

[Blackland_Trust]

Most think tanks (CSIS, RAND, IISS, etc.) estimate the probability of a Chinese military attack on Taiwan at around 10–20% in the coming years. My gut feeling says the probability is significantly higher. I expect China to initiate escalation in 2027. This doesn’t necessarily mean an immediate amphibious landing, but could be a naval blockade, limited military pressure, cyber and information warfare combined with disruptions to trade routes, or something in between.

Why 2027?

• Xi Jinping has given his People’s Liberation Army the official goal of being “basically ready for a Taiwan operation by 2027”. (The same year also marks the PLA’s centenary) When the state leadership no longer derives sufficient legitimacy from economic growth and promises of the future, it shifts attention to an external threat or a historical mission.

• The US’s dependence on Taiwanese semiconductors will still be evident in 2027. Furthermore, replenishing weapon stockpiles depleted by the war in Ukraine will take time, and a dedicated processing and separation chain for rare earth metals, which rely on fragile supply chains, has not yet been built. The US would not want a long and exhausting conflict with China - at least not yet in 2027.

• Post-Ukraine war Russia, through its still-pulsating war economy in 2027, will keep Europe’s attention focused on its own direction – synchronized with China’s strategic window. The West’s ability to respond to a Taiwan crisis will weaken. Of course, nothing certain can be said about peace and the pulsating Russian war economy right now…

How will stock markets react?

An attack on Taiwan would likely have significantly greater impacts on global supply chains than the war in Ukraine. The market reaction would hardly be a “COVID-type V”, but rather, accompanied by an ugly initial panic, liquidity would quickly retreat rapidly. During a slow, volatile recovery, many companies and asset classes would experience a more permanent re-rating. Energy, defense, and certain raw materials would probably see a bit of a surge.

I would like to hear others’ views, especially on these questions relevant to investors:

1. Which supply chains would fail first?

2. Which individual companies would benefit most from the West’s forced self-sufficiency? Which would lose?

3. Are there already signals in the markets pointing to this scenario?

I am not looking for a definitive answer to “will there be a skirmish or not”, but rather how this risk should gradually start to be priced into investment decisions, or should it even be?

Institutions likely already have the compiled views of think tanks fed into their systems as a precaution. Let the forum’s collective intelligence act as a think tank for the private investor - just in case.

All views, absolutely including opposing ones, are welcome! Hopefully, this will generate discussion.

[Vara-Paavi]

I’ve been trying to ponder something similar, but perhaps more from the angle of which assets best withstand the initial turmoil (i.e., take the smallest losses, or even a positive change in value), so that there’s something to allocate broadly to indices amidst the panic. Such a time is too volatile and unpredictable for me to necessarily start selecting a small number of companies, even though, if successful, multi-baggers would certainly be found there. For me, however, e.g., a +60% short-term return is sufficient, e.g., by catching an overreaction.

[Blackland_Trust]

The post-attack period would be extremely volatile and one-sided, but would it be entirely unpredictable in all respects? I.e., one purpose of this thread is to try to make the unpredictable at least somewhat predictable.

If one thinks in terms of supply chains, it is quite clear to me that certain chains would collapse in the West within weeks or months: semiconductors, energy, critical minerals, and the defense industry are all, in one way or another, dependent on either Taiwan, China, or geopolitically fragile choke points. It would not be a big surprise if serious disruptions occurred in these chains.

COVID is probably some kind of analogy. In the initial shock, everything was sold off, but already after a few months, it was predictable which industries underwent a more permanent revaluation and which benefited from the new environment, remote work, etc. At least I myself didn’t manage to see these in time from an investment perspective.

Therefore, I approach this less as a question of “what happens immediately after the ruckus begins” and more as a question of which companies will emerge as winners in the new world after the shock, when supply chains are forced to be rebuilt. Which positions will be cleared from portfolios in the future when China announces new military exercises around Taiwan, and with what will that portfolio begin to be filled when the entire market plunges to its depths?

I don’t see greed preventing one from becoming a better investor. As long as one is greedily risk-adjusted in that way. On both sides of the COVID dip, I threw my cash into the markets, making quite good gains, as did many others. However, I would have made much more significant gains if I had understood back then what seemed clear in hindsight. Still, a quick +60% would be acceptable to me in quite many scenarios.

[PeeJii]

I have also pondered this, especially from the perspective that the USA’s eagerness to disengage from Ukraine might partly stem from more serious risk assessments regarding the Taiwan situation presented publicly by the US military and other entities (and not just Trump’s foolishness).

However, it’s difficult to say how much of this is priced in, and how stocks in different sectors, etc., would react if the situation truly escalates. Additionally, the economic sanctions almost certainly to be imposed on China in such a situation make this even more unpredictable.

Here are some thoughts:

• Defense industry: Multiples are already high. Would an escalation in Taiwan still strongly boost these stocks, especially since the duration of the situation is initially difficult to assess?
• Logistics companies: Firms specializing in international freight, and especially those with capacity outside China, could benefit as companies ordering raw materials, etc., from China start buying elsewhere. On the other hand, purchases might also temporarily freeze due to uncertainty.
• Consumer goods, cars, etc.: These could get some kind of “buy American” patriotism boost, especially in the US. Of course, the biggest beneficiaries would probably be small, more local consumer goods producers, which are quite difficult to invest in directly (perhaps through Shopify stock, because e-commerce runs on it or something similar?).
• Raw materials: Which raw materials are imported most into the USA from China? Companies producing these elsewhere could get a boost, but hitting the right company might be difficult.
• Pharmaceutical industry: The pharmaceutical industry is typically a safe haven during uncertain times and could benefit from rising investor demand. On the other hand, a fair amount of pharmaceutical raw materials also seem to come from China?
• Shorting / S&P or Nasdaq inverse ETFs, etc., products benefiting from a decline: These could be effective strategies, but the risk, of course, is that the market continues to soar for the next few years and the reward is ultimately insufficient. Plus, at least I wouldn’t have the courage to short Nvidia, for example

[Mzazz]

Good thoughts! I myself am currently looking at companies with a relatively short logistics chain, as well as those whose logistics chain is largely integrated. I’m also looking at local operators, those whose production/business is close to their own customers. I believe that international trade, in general, is on shakier ground than people think.

I use short instruments relatively often. Usually, I tend to be “perma long”; I typically react to overpricing and geopolitical risks through allocation changes. But admittedly, it’s easier to just put a few shorts as a hedge.

[Chuckecheese]

What comes to mind quickly about companies that could surge as a result of an attack or other trade embargo: at least rare earth material producers and processors like MP Materials, which is currently the only company operating on US soil that already has mining operations underway. Of course, there are others coming in the US that aim to build operations around mining, such as Ramaco Resources or USA Rare Earth.

I could also imagine that among semiconductor manufacturers, TSM would suffer, even though it is building production in the US, but in its strategy, it wants to keep most of its production in Taiwan. Could Intel, “under duress,” get new orders in this situation and perhaps get a boost in its efforts to improve its production process?

However, I think that generally the semiconductor sector would take a really hard hit initially as the crisis escalates, as many companies are tied to China-Taiwan in many ways. These are just a few things that quickly came to my mind.

[Jackfin]

Of the investors I follow, David Orr talks quite a bit about this topic as a tail risk to hedge against, and his approach to the matter is to bet 0.xx% of the portfolio twice a year on derivatives in case of an attack. Why?

Weather conditions for a landing are favorable in the spring and autumn due to the currents and wind off the coast of the island. The idea does not take into account if the attack were to start as a blockade that would progress into a landing over time.

Because it is a small position in the portfolio and the bet is repeated, it is clearly a derivative with a short maturity and its strike price is far from the current one. The market thus assigns a very low probability that the price will crash there instantly. Especially in short-maturity derivatives, low probabilities are assigned to it, making the reward disproportionate. Since it is only a small part of the portfolio, the option will very likely expire completely worthless. It is therefore insurance – it is an expense until it protects against damage.

The way I would approach this myself is by buying put options on an ADR stock. ADR because you don’t actually own anything https://www.investopedia.com/terms/a/adr.asp and in such a situation, the stock would be more worthless than Russian stocks in the face of the invasion of Ukraine. It might be best if the stock did not have a trading venue in Hong Kong so that no one could play arbitrage, etc.

However, here is an example of options for a stock that is also listed in HK, but whose shares are traded in the US as an ADR – Alibaba.

I arbitrarily chose a 6-month maturity for May '26 and a 100 USD strike for the derivative. The last price for the option itself was about 1 USD. In this theoretical example, the stock crashes immediately from the current $150 → $50. As a result, the value of the option rises in theory from $1 → $50. You make a 4800% return, and for example, a 0.25% share of the portfolio is now 10.7%.

I used the word “in theory” because the price of the stock and the option do not necessarily move exactly 1:1. If the option expires very soon, the option might behave in the way I presented, but if the maturity – the option’s duration – is long, the market assigns a higher probability that the situation will normalize and the option will not perform as well as hoped.

In my opinion, this kind of hedging is the most sensible. You sacrifice a small piece of the portfolio and can focus on making investments instead of increasing your cash weight or investing in sectors that specifically work in this unlikely scenario – you miss out on returns.

Critical minerals as a sector will probably work as long as production hasn’t been ramped up in the West.

Defense industry, I guess?

During military crises, gold and oil have usually risen, but I’m not really sure about gold. The following stock market crash from that would be so severe that most asset classes would probably collapse, and shorters would be the only ones making certain profits.

The dollar might act as a safe haven. I have thought a lot about whether China could bring the United States to its knees by appealing to its capital market-driven nature and mercilessly selling government bonds? I have come to the conclusion that it is at least not the first scenario ahead, because China has constantly sought to reduce the amount of US Treasuries it holds and diversify by buying gold – which diminishes the power of this trump card.

[massimo]

Semiconductors and fabs outside of Taiwan crossed my mind as well. Is there any other option for these besides just hanging onto Intel in the portfolio?

[kassavirtaa]

Thank you for opening an excellent thread and for your reflections/background. I also believe that the probability by the end of '27 is higher than 10-20%, and at minimum an embargo (but hardly over 50%?). Starting with the big picture, there will be strong political rhetoric from the West (EU and USA) as well as some form of sanctions, but then it will be realized how China dominates various supply chains. The consequence would thus be rising inflation, periodic hoarding, and even shortages. This could even drive Europe into some kind of stagflation.

What would the ECB do in this situation, when interest rates couldn’t really be raised? In practice, China-driven businesses and assets in China would be under significant pressure. The biggest issues are the aforementioned semiconductor availability/price and rare earth metals. Oil is the most difficult commodity to evaluate because it depends on what, for example, Russia and Iran do. The USA would surely seek to ensure its own supply by urging its producers to drill more, as they would want to minimize the rise in inflation.

In addition to those mentioned in previous posts, China’s massive scale in the chemical industry and especially in the production of pharmaceutical raw materials would surprise our politicians. There would be shortages of cheap generic drugs for cholesterol, antibiotics, and blood pressure in the EU and USA, with prices multiplying and periodic shortages occurring (the effect would only hit with a 6-12 month lag). China’s impact would also be significant on our technology industry because factories are owned there (nationalizations would occur on both sides, but China would make the first move immediately).

Stock prices would face heavy selling pressure in this scenario, depending of course on what central banks do. If we allowed inflation to rise slightly (to 4-5%) without raising interest rates, we would fare a bit better. Which sectors/asset classes would benefit instead? The defense industry and cybersecurity, for sure. And all those sectors that currently only have production in the EU/USA region and have suffered from cheap Chinese imports, but whose products are so-called essential goods. For example, Outokumpu could be such a company. I believe gold would also hold its ground well. As the world divides, it would benefit from the fact that everyone can store their own gold without the counterparty risk found in bonds, for example. Of course, also those companies that can pass on rising inflation mainly into their prices and, ideally, where cost inflation is clearly below consumer inflation.

Cash and cash-like assets (safe short-term bonds), as well as precious metals and the aforementioned stock sectors, would, in my view, provide security for an investor.

Unfortunately, the world would divide into blocks/spheres of influence in this scenario. China/Russia/Iran would be one. The USA another, with whom the EU and the Brits would be both together and separately, with interests diverging in places. India’s role is unclear to me. It would try to play friend to everyone while attempting to benefit from the situation, but which way would it ultimately lean?

In this scenario, we would pay a high price for our naivety in having outsourced a significant amount of manufacturing to China. Not all manufacturing could be brought back even in a couple of years due to investment cycles.

[Stefa_hoitaa]

If China attacks, the consequences in my scenario depend on what happens to TSMC’s fabs in particular. Whether they end up intact in Chinese hands or are destroyed in the attack, either by China or someone else. If they fall into Chinese hands in more or less working order, the future is difficult for me to assess. Much depends on what the Chinese do with the production. For example, if they refuse to sell any production to Nvidia, AMD, etc., the US might well decide that they won’t let China have that production either and bomb the fabs.

This leads to the question of what happens if the fabs are destroyed. The world would be set back 5–10 years in terms of high tech. Additionally, there would obviously be availability issues across all industries that use semiconductors, as total capacity would drop drastically and the most advanced chips would no longer be available.

Intel would likely be a winner in this scenario. Of course, they wouldn’t be able to ramp up capacity with the snap of a finger either. They could, however, hike up their margins. I won’t speculate on other potential winners. My guess is that stock prices would crash across the board. That’s how dependent the Western world especially is.

If the aforementioned scenario were to play out, the US could also make a move to reserve all of Intel’s production for domestic needs related to national security. If necessary, they might even seize (not buy) control of the company. In that case, non-US investors at least would be left holding the bag.

[JNivala]

I’ve also been pondering this “Taiwan dilemma” a lot. For background reading, I highly recommend everyone read the book “Chip War” mentioned on this forum as well. It’s an excellent introduction to this topic and to the world’s most critical, difficult, and important technology in general.

TSMC’s factories are so critical to the technological development of the entire world that if China were to attack Taiwan in any way, it would trigger a systemic crisis, which in practice means a stock market crash. Temporary, of course, but it’s hard to believe that stock markets wouldn’t collapse globally. What would happen? Here’s a quick list:

• Technology would indeed jump back about 5 years, and semiconductor supply chains would go completely haywire again. This would have long-term global effects. AI stuff would tank completely, NVIDIA’s business would be destroyed for a while, etc. Productivity would take a hit.
• Uncertainty would increase significantly. We would likely see erratic behavior across all sectors: major demand spikes (hoarding), waves of unemployment, and preparing for the worst.
• Consumers would be completely confused. Should I clear out the store’s stock of the latest Apple products when they won’t be available for years? Will the market for used products rise? Or should I save everything now since no one knows what’s happening in the world?
• If this happens within the next 1-3 years, it essentially means World War III is a certainty. Uncertainty increases through this as well, not just through semiconductors.

Is this underpriced then? In practice, only a few people in the world know the real risk/probability of this happening. You simply can’t discount such a risk into the stock markets in advance. In my opinion, as an investor, it is just good to understand what happens if China attacks Taiwan. The result of my long-term reflections is a systemic crisis where we see classic crash-like 40-60% drops in global stock markets. There would be few winners, but for example, Intel could indeed be one. In a “semiconductor basket,” Intel could actually be quite excellent specifically as a “hedge.”

At least I have a precise playbook written down in WRITING on how I will act if the event in the title occurs