Nvidia investors should watch out for this key risk that could trigger a double-digit semiconductor stock plunge in the next 12 months

• The sell-off for semiconductor stocks might not be over, according to BCA Research.
• Rising geopolitical risk between the US and China could seriously tank Nvidia share prices.
• Here's how to protect your holdings from an escalating trade war.

It's been a rough few months for investors who bought into the AI trade last year.

If general recession fears and a trade war stifling the chip industry weren't enough bad news, investment research company BCA Research is ringing the alarm bell on an even bigger risk: a full-blown war between the US and China over Taiwan.

In a recent report by two of the firm's strategists, Marko Papic and Matt Gertken, BCA Research doubled the odds of a full-scale conflict between the two countries in the next 12 months from 5% to 10%.

How a US-China war could play out

While most Liberation Day reciprocal tariffs have been paused, the tariff rate on Chinese goods remains at a whopping 145%. And while Trump on Wednesday announced plans to soften his stance against China, no concrete details about deescalating tariffs have been released.

"President Trump has just raised tariffs to levels that, if sustained, will halt US-China trade. Combined with export controls, looming investment restrictions, and various other existing or threatened sanctions, the US strategy will start to look like an all-out economic war against Beijing," Papic and Gertken wrote. "That would give Chinese policymakers significant domestic cover for retaliation that goes beyond trade."

Essentially, Trump's tough negotiating tactics have put the US at an elevated risk of war by backing China into an economic corner, and China might have enough at stake to incite a military conflict, BCA Research believes. US GDP growth is highly dependent on consumer activity, but that's not the case for China. While roughly two-thirds of the US economy consists of consumption expenditures, China's is 39%, making it more reliant on exports to grow its economy.

Ed Yardeni, the president of Yardeni Research, recently echoed similar concerns around a Chinese invasion of Taiwan.

"The Chinese economy is much more vulnerable than is the US economy to a trade war between the two superpowers," Yardeni wrote in a note last week. "President Xi might conclude that now is a good time to invade Taiwan since Trump has played his tariff card and Xi needs a diversion from the calamity about to befall his economy."

BCA Research sees another 25% chance of a small-scale proxy war breaking out, for a cumulative 35% probability of some sort of geopolitical conflict playing out in the next 12 months.

Semiconductors at risk

Taiwan plays a critical role in manufacturing advanced semiconductor chips that tech giants like Nvidia, Apple, and AMD depend on. If China feels threatened by Trump's tariff policy, it could retaliate by either blockading or invading Taiwan, cutting off vital resources for American companies.

In the worst-case scenario, which BCA Research has dubbed "WWIII," expect to see a severe economic impact from a military conflict between the US and China. The firm predicts the S&P 500 would take a 40% hit in such a situation, led by plunges in semiconductor giants like Nvidia and Taiwan Semiconductor.

"Much of Taiwan's most precious fixed asset investments — including its prized semiconductor fabs — would be destroyed by Taiwan itself or the US as Chinese forces approached, thus defeating the technological benefit of unification," Papic and Gertken wrote.

In the case of a proxy war, such as if China launches a partial invasion on Taiwan, BCA Research predicts a 10% drawdown to the S&P 500.

How to prepare

Investors shouldn't worry too much over the possibility of an all-out military conflict — BCA Research estimates there's a 65% chance that the status quo will prevail. But the fringe case's impact on markets is highly devastating and worth hedging against, Papic and Gertken believe.

"Investors should consider deep out-of-the-money insurance against a calamitous event," wrote Papic and Gertken. "For example, bets on large double-digit declines in Taiwanese stocks, or TSMC or NVDA share prices."

As an example, let's say Nvidia stock is trading at $100. If you're concerned about a military escalation that would seriously disrupt the company's business model, you could buy a put option with a strike price of $70 that expires in 12 months. Since $70 is far below the current price, the option will be deep out-of-the-money and cheap.

In the worst-case scenario, you'll be able to sell Nvidia for $70 if the stock price dips below that level. The option itself also becomes more valuable, and can be sold for a profit. If the stock doesn't plunge, your options will expire and you'll forfeit the cost of the options, but it's a small price to pay for insurance, Papic and Gertken said.

"Investors should buy insurance against this tail risk while it is cheap," they wrote.

Another way to hedge against the US-China trade war is to increase your allocation to emerging market manufacturing companies, BCA recommended. Examples of emerging market funds include the iShares MSCI Emerging Markets ETF (EEM) and the Schwab Emerging Markets Equity ETF (SCHE).

Unsurprisingly, gold is another trusty hedge against geopolitical risk. BCA predicts the yellow metal will see a 40% boost in the case a full military conflict breaks out, and 10% in the case of a proxy war. Investors can get exposure to gold through funds like the Goldman Sachs Physical Gold ETF (AAAU).