What happened

News headlines this morning are dominated by the U.S. Department of Labor's announcement that inflation in November was up "only" 7.1% over a year ago -- good news, given that most economists were predicting 7.3% inflation.

Investors are responding positively, with semiconductor stocks in particular benefiting today. That's probably due to hope that decelerating inflation will convince the Federal Reserve to raise interest rates only 50 basis points at tomorrow's meeting, rather than the 75 basis points that have characterized the past several hikes.  

Shares of Intel (INTC -1.26%) gained 3.8% through 10 a.m. ET on Tuesday, and Broadcom (AVGO 1.68%) rose 3.9%, while Advanced Micro Devices (AMD -1.20%) led the chips sector higher with a 5.5% gain.

So what

Semiconductor stocks would benefit from lower interest rates at the federal level. But that's not what we're getting. We're probably getting (in the best case, I suspect) is another 50-basis-point hike in interest rates on Wednesday. This will slow the economy less than a 75-point hike, but will still slow the economy and raise the cost of debt -- and both Intel and Broadcom carry a lot of debt; AMD less so..

Nor is this the only worry semiconductor investors have today.

The Chinese government is about to announce plans to give its semiconductor industry $143 billion in new subsidies for production, as Reuters just reported. Beijing has two aims with this move: First, to counteract U.S. technology restrictions on exports of semiconductors and semiconductor manufacturing equipment to China. And second, to respond to the Biden Administration's giving about $77 billion in subsidies to semiconductor manufacturersin the U.S.  

Now what

All this taxpayer money being poured into semiconductor makers means companies' costs will fall as the two governments do much of the heavy lifting. And that will boost production -- and profits -- for semiconductor companies.

Some $220 billion combined in subsidies in just the U.S. and China alone is likely to encourage production of more semiconductors. But with the supply of chips shifting from deficit to oversupply already -- even before the subsidies arrive -- such increased production could result in overproduction. This could cause the price and profit margins on chips to fall.

And the competition over which country can subsidize semiconductor production the most isn't likely to remain limited to China and the U.S. As companies in these two countries gain market share and drive prices down for everybody, governments in Japan, South Korea, and Europe will likely feel compelled to respond with subsidies for their own companies, snowballing the effect of rising production and falling profit margins.

So there's rising potential for a global semiconductor glut, driving down profit margins, potentially for years. If so, then investors should start thinking about exiting the semiconductor sector, or at the very least gravitating toward chip companies that have higher profit margins -- so they'll have more room to sacrifice margins and still remain profitable when margins start coming down.

Right now, Broadcom's gross margins are the highest of the three at a robust 75%, while Intel's margins are weakest at 47%. And the fact that Broadcom's valuation is also the cheapest of the three, at 13.4 times forward earnings, is yet another reason to favor Broadcom over either AMD or Intel.