This article is a high level overview of our market research. It will be updated from time to time.
The historical task of the complete reunification of the motherland must be fulfilled and will definitely be fulfilled.
- Xi Jinping, October 2021.
In the face of wars that may be imposed on us, we must speak to enemies in a language they understand and use victory to win peace and respect. In the new era, the People’s Army insists on using force to stop fighting. . . . Our army is famous for being good at fighting and having a strong fighting spirit. With millet and rifles, it defeated the Kuomintang army equipped with American equipment. It defeated the world’s number one enemy armed to the teeth on the Korean battlefield, and performed mighty and majestic battle dramas that shocked the world and caused ghosts and gods to weep.
- Xi Jinping, October 2022.
Reviewing the past five hundred years, the Harvard Thucydides’s Trap Project has identified sixteen cases in which a major rising power has threatened to displace a major ruling power. Twelve of these sixteen rivalries ended in war.
A rupture between Taiwan and China could cause the U.S. a great depression and be catastrophic to both the Chinese and American economies.
- Ken Griffin, January 2024
Table of Content
The Bottom Line
Geopolitical risks in Southeast Asia have reached their highest levels since WWII.
More than 75% of the semiconductor foundry market is based in Taiwan (65%) and South Korea (13%). Semiconductors are the lifeblood of all electronic devices. Close to 90% of advanced chips required for AI applications come from Taiwan.
The odds of an armed conflict between China and the U.S. are at 75%, based on data analyzed over 500 years. Yet, only 8% of experts surveyed believe it can happen in the next 10 years. President Xi has required that all departments be ready for war before the U.S. elections.
An invasion of, or China sponsored political coup in, Taiwan would represent a major generational shift in international relations and financial market dynamics and create massive supply chain disruptions.
Traditional 60/40 portfolios are facing strong headwinds ahead.
Financial advisors and active investors must reintroduce geopolitical risks as a top risk factor in portfolio management.
Passive investors should consider implementing more active strategies and review their downside exposure and cash needs.
Active investors should consider rebalancing their portfolio and reassess their equity exposure, in particular after the 2024 U.S. elections, at which point we believe risks of a conflict in the Taiwan Strait will be heightened.
War is not inevitable but a risk of collision is heightened if both alliances stay on their current course.
Some Context First
Note: this article was first published on August 25, 2023 and has been updated on many occasions since.
Geopolitical risks have reached their highest levels since WWII. China, Russia and their allies are coordinating their efforts to create a new world order.
We are now witnessing changes the likes of which we haven't seen for 100 years. And we are the ones driving these changes together.
- Xi Jinping to Vladimir Putin, March 2023
It is also important to understand the Chinese nationalistic mindset as you go through this article. We have to go back 100-150 years to understand how Chinese nationalists then and now perceive Western influence.
Just a century ago, Chinese have witnessed, in their own words, a "Century of humiliation". It refers to the period of intervention and subjugation of the Qing dynasty and the Republic of China by Western powers and Japan from 1839 to the 1940s. The Opium Wars waged by Western powers in China are definitely a low point in the history of Western powers.
So when Xi Jinping talks about the Great Rejuvenation of China, you need to have this historical context in mind.
There is a Chip War going on between China and the US (and its allies) and it has been heating up since the US first adopted an export-ban on semiconductors to China in October 2022 and then August 2023.
A great majority of advanced artificial intelligence applications run on chips made in Taiwan. Almost 90% of advanced chips are made in Taiwan.
Taiwan Semiconductor Manufacturing Company's market share of semiconductor foundries worldwide is more than 50%. TSMC and Samsung have a combined market share close to 75%, all concentrated in the same region: South East Asia.
What is going on in China?
Early signs of the preparation for war can usually be seen when a country experiences or does the following, in the context of rising geopolitical tensions:
the economy is experiencing a systemic contraction as a result of a boom-bust cycle. China is currently experiencing a real-estate bust;
major companies are defaulting on their debt, in particular international debt; Evergrande and other real-estate conglomerates have defaulted on their international debt recently.
the youth unemployment rate increases significantly. In China, the youth unemployment rate has exceeded 20%, and some sources claim it has reached almost 50%.
a crackdown starts on entrepreneurs, influencers and religions. Key influential figures just disappear from the public stage.
key economic data is no longer published by the government.
businesses are encouraged to convert their international currency holdings to the local currency. Chinese businesses swapped $31.5bln for yuan with banks in onshore forward markets in July, the highest in record.
the army high command is replaced with a more radical leadership.
the narrative towards a new world order and war becomes prevalent. False claims from the authorities become prevalent. Government officials' speeches become aggressive towards its neighbors (here, the Philippines, Japan, South Korea and Taiwan mostly).
field hospitals are being built near launch bases - see what happened below when we tried to get more information about the new field hospitals being built in the Fujian Province ... the access was forbidden:
We found out that Fujian and several cities in the province began preventing overseas IP addresses from accessing government websites, possibly to impede tracking of China’s preparations for war.
commodities are being hoarded and stored by the government including oil, grains and metals.
China has been buying gold in 2023 at a record pace. Somewhat odd during a real estate bust and rising unemployment.
China has been hoarding copper at a record pace in 2024:
lands are being seized to produce more grains or for military installations.
army recruitment increases significantly and new armement is built at an accelerating pace. From 2015 t0 2019, China's military spending grew nearly twice as fast as China's official GDP in real terms.
a divestment from international assets accelerates.
trade with Bell & Road initiative countries increases significantly while trade with the US, EU and Japan falls considerably.
capital controls are put in place.
travel controls are put in place.
demographics are shifting against a desired trend.
new laws are enacted to allow the government to seize properties owned by foreign investors, to stabilize markets and implement drastic anti-spying laws.
bans on foreign companies and technologies are put in place.
the country doubles down on espionage, in particular digital espionage.
China's militia ships increase their presence in the South China Sea by 35%.
broadening economic and military alliances are put in place. China, Russia, India and Brazil recently invited Argentina, Egypt, Ethiopia, Iran, Saudi Arabia and the UAE to join the BRICs alliance in January 2024.
All of the above is happening right now in China.
UPDATE Q1 2024: President Xi gave a speech 3 days after the Taiwan elections saying Abandon illusions, prepare for struggle and complete the great cause of reunification of our motherland, which he has promised to achieve in his end of year speech to the nation, as per this independent intelligence report.
Please watch the video from the Hudson Institute for a comprehensive analysis on the recent years' timeline confirming China's preparation for war.
Meanwhile, the U.S. pursues a silicon blockade against China, by cutting China off from advanced computer chips, chips that are essential to any country that relies on advanced technologies such as quantum computing and artificial intelligence.
As recently as last April, China spent more money importing semiconductors than it did for oil.
One could say that this export ban is a declaration of economic war against China. Could the plan backfire?
After all, the U.S. went to war to secure its oil supply. Could China go to war to secure its own supply of advanced semiconductors?
How it could play out
From a military standpoint, we believe that China would have the capacity to take Taiwan in just a few weeks.
However, China does not want to be viewed as the aggressor. It could therefore first implement an economic blockade enforced by the PLA Navy, similar to how the U.S. implemented a naval blockade of Cuba during the Cuban missile crisis.
A blockade would lead to either (1) a partial or full settlement over the Taiwan situation, trigger trade negotiations including on the semiconductors export ban by the U.S. and its allies and redefine the U.S. presence in South East Asia, or (2) a military confrontation over Taiwan. However, we doubt that a blockade would be the right strategy to coerce Taiwan to reunify with China. Moreover, it would kill the element of surprise, which is, in our opinion, a very crucial aspect for a swift takeover of Taiwan.
One of the least discussed scenario right now, yet probably one of the most cost-effective one, would be a political coup in Taiwan. We believe China is currently envisioning such a coup with the help of the Taiwan opposition (KMT and TPP) and an airborne assault force to secure all key infrastructure in Taiwan.
Should China however decide to go with a military offensive on Taiwan, it could go like this:
multidomain attacks to paralyze U.S. intelligence, communications, and command and control systems and force individual units to fight in isolation;
preemptive, strategic and highly precise missile strikes on key Taiwanese installations to destroy their defense capabilities and effect a complete communication blackout on the island;
a 360 Naval blockade of the island to cut supply and foreign assistance;
thousands of paratroopers would be sent on the island to secure key infrastructure, in particular all TSMC semiconductor facilities;
A formidable amphibious assault force would land on multiple strategic landing zones to quickly encircle Taiwanese troops;
We expect China to succeed at perfecting the modern form of Blitzkrieg with an extended use of advanced technologies (ex: supersonic missiles), highly motivated troops, real-time data, digital espionage and deceptive practices.
The Western world may not have enough time to do anything about it.
The PLA represents a formidable armed force with 2 million+ well trained troops and the biggest navy in the world. The PLA answers directly to the Communist Party.
In any event, we believe that the US would not come to the rescue of Taiwan and risk destroying key technology factories on the island. Moreover, the US needs a narrative to convince its population to go to war. A move on Taiwan and the global economic shock triggered by it, would certainly represent the catalyst for such a narrative, like the Japanese attack on Pearl Harbor did.
What about timing
US intelligence services think that a move on Taiwan could happen as soon as January 2024, when Taiwan will have its next elections.
The CIA said President Xi Jinping has set 2027 as a deadline for the Chinese military to be ready to carry out a Taiwan invasion.
A US Air Force General predicts a war with China by 2025.
In a speech to senior members of various PRC departments, made 3 days after the Taiwan elections, President Xi called for all departments to be ready for war before the 2024 U.S. elections.
The Taiwan Strait is 110 miles wide. Naval experts believe there are only 3 months in the calendar that would allow for an amphibious assault on Taiwan and those months are April, May and August.
The reality is that nobody knows for sure other than the protagonists.
What could be early signs of an imminent attack?
Near-term indicators of approaching conflict would include financial elements such as imposition of stronger cross-border capital controls, a freeze on foreign financial assets within China, and rapid liquidation and repatriation of Chinese assets held abroad. It would also include a surge in stockpiling emergency supplies, such as medicine or key technology inputs; a suspension of key exports, such as critical minerals, refined petroleum products, or food; measures to reduce demand or ration key goods, especially imports such as oil and gas; and prioritization or redirection of key inputs for military production. Chinese elites and high-priority workers would also face international travel restrictions.
We are also closely monitoring the situation in Hong Kong as a military move over Taiwan would necessarily originate from Zhanjiang, Guangdong, China and from the Pearl River Delta just north of Hong Kong.
On March 7, 2024, Chinese Vice-Premier Ding Xuexiang calls for swift Article 23 legislation, saying it will safeguard ‘core national interests’ in Hong Kong. The Article 23 legislation, sitting alongside the Beijing-imposed national security law, will target five new types of offences – treason, insurrection, sabotage, external interference, and theft of state secrets and espionage.
We believe a campaign across the Taiwan Strait could start with a major military exercise : US Army satellites track unusual PLA troops movements so a justification must be provided.
Just like these:
These exercises will become more prevalent in the South China Sea and will disensitize the media about the probabilities of a real invasion.
That being said, government narrative is one of the most important indicator that one can track to assess a potential timeline for war.
We believe that we first need to see a change in the narrative (from belliqueux to extremely aggressive) from China officials or see an incident in the South China Sea or Gulf of Tonkin like incident before a move on Taiwan can happen - a government needs to create a story that sticks with its population and that will trigger its population's willingness to go to war. The current narrative does not seem to be aggressive enough towards Taiwan, South Korea or Japan although China has just recently increased the blame game towards Japan for releasing radioactive contaminated water.
UPDATE Q4 2023: the Chinese narrative is getting more aggressive towards Taiwan and the U.S.
We think a move on Taiwan before the 2024 elections would be unlikely from a current narrative point of view. However, we know that Chinese are very methodical planners and they will want to keep the element of surprise at all costs knowing its strategic importance.
The initial PVA assault began on October 25, 1950, under the command of Peng Dehuai with 270,000 PVA troops. The PVA assault caught the UN troops by surprise, and employing great skill and remarkable camouflage ability, concealed their numerical and divisional strength after the first engagement with the UN. After these initial engagements, the Chinese withdrew into the mountains. UN forces interpreted this withdrawal as a show of weakness; they thought that this initial attack was all that the Chinese forces were capable of undertaking.
One optimal surprise scenario from the Chinese point of view, would be to act during a weekend when international leaders gather for a G7 or G20 summit. It would leverage the absence of international leaders from high military command, limiting their capability to respond rapidly. So lights should turn red when Xi Jinping announces that he will skip one of these summits, like the one in India scheduled on September 9-10 2023.
China does not want an all out war but it wants to send a strong message to the world that Taiwan belongs to China and that the US, Japan and other Western countries should stop meddling into the politics of the South China Sea region.
Russia's troubles in Ukraine are also adding pressure to Xi's own timeline. A prolonged war in Ukraine would weaken Russia's army, China's strongest military ally and "no-limit" partner.
The 2024 elections in Taiwan and in the US are going to be the most important elections of this decade.
UPDATE Q1 2024: since the results of the Taiwan elections have somewhat pleased Beijing, given the circumstances, we do not believe that a military campaign against Taiwan would occur at any time before the U.S. elections. We think investors should be cautious if there is a change of administration in Washington. From a tactical standpoint, we believe that a very good window for a surprise attack from China would indeed coincide with a transition period in Washington. The 2024 US holiday period would represent such a period of slow reaction time and potentially confusing directives in the US in the event of a Chinese surprised attack, especially with a change of administration in Washington.
Possible Timeline for a move over the Taiwan Strait
Taiwan Elections 2024 | January 13, 2024 |
Best weather | April, May, August |
William Lai Ching-te takes office | May 20, 2024 |
U.S. Elections | November 5, 2024 and following |
U.S. Christmas Holidays | December 25 - January 5, 2025 |
Chinese (Lunar) New Year | January 29 - February 12, 2025 |
Finally, watch the price action of all major asset classes. By watching the tape we can often notice that something is brewing. For instance, a cross-asset contraction of volatility on higher timeframes is a warning sign that a disruptive event may occur. Contraction of volatility always precedes expansion in volatility in liquid markets. The current extreme contraction in volatility is worrisome.
It is worth noting that a belligerent state can now profit from a significant, disruptive market event that it knows will happen. It means that China can finance in part the war it intends to wage by positioning itself in the financial markets before it triggers the event. That is something that could not be done decades ago. But with the opacity of multi-jurisdiction corporate structures, the ease of global financial transactions and the liquidity of international financial markets, it can be done today.
Moreover, China knows that it can substantially weaken Western economies by taking markets by surprise. A move by China on Taiwan would destruct Western wealth at a speed and to an extent never seen before. When about 40% of westerners live paycheck by paycheck, it's hard to ignore the chaos such an event would create.
By watching the tape carefully in these various asset classes, one can find interesting clues, sometimes.
Right now, the tape is telling us that something major is brewing.
Yet, only 3% of experts surveyed on the China-Taiwan situation believes China will achieve unification within the next five years.
The Downside
What would be the impact on a traditional 60-40 portfolio (60% stocks, 40% bonds) if a war breaks out with China and global commerce shuts down?
We think it is reasonable to expect a significant drawdown in 60-40 portfolios by as much as -30% to -60% in a matter of weeks (that's without the use of any leverage!). The US dollar and inflation would spike up. Stagflation would be almost certain for years to come.
When Russia invaded Ukraine in February 2022, the MOEX index lost 60% from its peak in a matter of a few months. A lot of investors got burned in that parabolic upside move at a time when market participants completely dismissed geopolitical risks. Note the blow off top in the last quarter of 2021, just a few months before the botched surprised invasion. The market has since recovered by about 50%. But we believe the Russia-Ukraine conflict does not represent a material strategic economic conflict at this time.
If China does invade Taiwan, one could argue that the stock market would sustainably recover from such a systemic event only after a few decades of stagnation.
That would represent a systemic return shock for most pension funds and future retirees. It would create an important retirement crisis.
Although we would expect China to try to repair its relationship with the world immediately after a move on Taiwan - such narrative being already highlighted in China's Global Security Initiative Concept Paper, especially if a strike or political coup is quick and has low casualties, we believe trust will be lost for a pretty long time and political and war economies will replace the just in time global economy we have seen since China joined the WTO in 2001.
Xi Jinping wants a new world order as part of the "great rejuvenation of the Chinese nation" and has further territorial claims in the South China Sea.
This conflict in Southeast Asia would change the macroeconomics and geopolitical landscape for a generation.
The Geopolitical Risks
Most investors got immune to stock market corrections: the market dips, reverses then makes new highs. Business as usual, right?
The thing is that the great majority of financial advisors and investors dismiss macroeconomics and geopolitical risks.
The geopolitical risks we are highlighting here are the most serious ones to ever occur since the rise of Nazi Germany and Japan's military Empire in the 1930s. But never in the history of mankind has the global economy been so interconnected.
So the impact of this kind of geopolitical shock can create a gigantic economic shock that no one can measure at this time.
But it would, for sure, represent a logistical nightmare for hundreds of Western technology companies, such as Apple.
Just remember that a huge amount of international commerce takes place from or within the South China Sea, Taiwan produces 90% of the most advanced semiconductors used in electronic devices across the globe. China also controls the transformation of key raw materials, in some cases up to 90% of the export market. It produces 60% of the world's germanium and 80% of the world's gallium, according to the Critical Raw Minerals Alliance. It also dominates supply chains for rare earth minerals used in many high-tech products, as well as the lithium, cobalt and graphite used in batteries. It just started to impose export controls on key materials used for semiconductors.
Moreover, under China's Belt & Road Initiative (BRI), costly projects financed by China in Argentina, Ethiopia, Montenegro, Pakistan, Sri Lanka, Kenya, Zambia, and elsewhere have pushed debt-to-GDP ratios to unsustainable levels and produced balance-of-payments crises. A war and strong US dollar would only exacerbate this problem and allow China to take over strategic assets if any of these countries default on their debt.
After Sri Lanka fell behind on payments for its troubled Hambantota port project in 2017, China obtained a 99-year lease on the property as part of a deal to renegotiate the debt. The agreement sparked concerns in Washington and other Western capitals that Beijing’s real aim was to acquire access to strategic facilities throughout the Indian Ocean, the Persian Gulf, and the Americas.
[...]
The stakes for the rest of the developing world are enormous. This wave of debt crises could be far worse than previous ones, inflicting lasting economic damage on already vulnerable economies and miring their governments in protracted and costly negotiations.
Are you Proactive enough?
Successful investing should always put the focus on adequate risk assessment and risk management acquired through deep market research.
A great majority of passive investors has become way too much complacent and ignore these geopolitical and economic risks.
It is in time of peace and market complacency that investors should be proactive in addressing macro and geopolitical risk factors. Once events have played out, it's already too late. There is a time to play offense and there is a time to play defense. Right now, as a passive investor, you should consider playing defense.
Is your investment portfolio diversified and resilient enough to face these new geopolitical risks?
Chances are it is not.
We believe it is crucial you sit down with your financial advisor and review your portfolio allocation in light of this serious situation. Markets hate surprises and we believe China could take the market by surprise. Do not delay this exercise.
How 8X is preparing for it
UPDATED on Q1 2024
As a general note, our portfolio is always composed of various long/short positions in international markets, from equities to currencies, to bonds and commodities. We are very active traders in 60+ global markets and rebalance our portfolio regularly.
We believe a conflict in the Taiwan Strait is not probable before the U.S. elections. At this time, we believe certain sectors of US equities (read tech dominance) are extremely attractive from a global liquidity and momentum perspective. We are actually expecting a melt up and blow off top to form before the situation deteriorates in the South China Sea.
Bloomberg Economics estimate the price tag of a war in the Taiwan Strait at around $10 trillion, equal to about 10% of global GDP — dwarfing the blow from the war in Ukraine, Covid pandemic and Global Financial Crisis.
We plan to significantly reduce our exposure in equities after the 2024 U.S. elections and assess if short (or put options) positions are warranted in technology indexes and certain stocks significantly exposed to the Taiwan supply chain.
For instance, we believe that NVDA, AAPL and TSMC are extremely vulnerable to a conflict in the Taiwan strait.
We believe a war in the South China Sea would benefit the Indian, Japanese, South Korean, Indonesian, Brazilian and Mexican (Latin America in general) economies (but put additional pressure on the yen) as the Western Alliance would cease trade with China for an undetermined period of time. It would however create a lot of uncertainty for the economies of the former Indochina colonies (Vietnam, Thailand, Cambodia, Laos), Myanmar, South Korea and the Philippines which would be compelled to pick a trade partner.
War is not inevitable. Deterrence tactics on both sides are normal and can succeed in achieving just that: deterrence. However, we don't believe China will shelve its goals of reuniting with Taiwan and the tactics used to change the regime in Hong Kong are not replicable for Taiwan. The somewhat reckless tit for tat tactics aimed at each others' alliances are increasing the odds that something will eventually go wrong.
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Copyright. 8X WEALTH INC. August 2023.