investment viewpoints
3 reasons why we are positive on China tech stocks
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Need to know • Short-term volatility in China’s equity markets notwithstanding, we believe long-term drivers for China’s growth remain intact. |
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From a regulatory crackdown on sectors such as education and tech in China to pandemic-driven supply-chain dislocations, China’s equity markets have sold off on short-term concerns. The latest selloff in tech stocks followed the news of Chinese ride hailing company Didi Chuxing’1 decision to delist from New York and switch to Hong Kong.
The announcement, which comes against the backdrop of increased regulatory scrutiny in China, also had a ripple effect on Alibaba2 and Tencent3 stocks which tumbled along with Didi’s shares following the news.
But amid this volatility, the long-term policy architecture and market forces for enduring growth persist – even in the embattled tech sector.
That’s because the recent regulatory pressure and correction in tech stocks represent a bump on the long road ahead for Chinese growth, as planned in China’s dominant policy frameworks – the Five-Year Plan (2021-2025) and Vision 2035. Both champion greater tech R&D, artificial intelligence and quantum computing as part of an effort to grow the nation’s digital economy.
We believe this overarching policy direction will foster greater transparency and competition, and modernise China’s regulatory oversight in line with Western economy standards. But this view is not reflected by current valuations in China tech stocks – presenting opportunities for forward-thinking investors, in our view.
Now let’s unpack the drivers behind our long-term investment conviction in China’s tech sector.
Sources
1 2 3 Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.
China’s GDP growth is expected to regain momentum next year as it is predicted to step up both monetary and fiscal easing from Q4 2021. The nation also plans to triple its GDP relative to 2020 output as per its latest Five-Year Plan.
Unlike certain developed economies, China boasts of enough wriggle room to pump economic stimulus without triggering massive inflation. That’s partly due to the fact that it is the only major economy in the world to have avoided a pandemic-induced stimulus overdrive - instead offering more targeted support to smaller businesses hit by the pandemic. It has also managed to contain inflation due to stable food price increases.
Still, given the backdrop of challenges faced by the world’s second largest economy this year including a power shortage, shipping delays and a real estate crisis, China's Politburo has signaled that it may take more aggressive actions to protect the economy in 2022.
The Chinese Communist Party's leadership team, chaired by President Xi Jinping, said in a recent statement that "ensuring stability" would be a top priority in the coming year.”
This was demonstrated with the People’s Bank Of China on Monday announcing a cut in the required reserve ratio for most banks starting mid-December, unleashing about 1.2 trillion yuan (USD188 billion) for business and household loans.
We believe the negatives from recent regulatory action have largely been baked in, offering investors an opportunity to participate in China’s long-term growth story at attractive valuations.
In the year so far, the Asian giant witnessed a regulatory storm with government cracking down on various sectors including the internet, tutoring, fintech, property, healthcare, media and energy. This has wiped off more than a fourth of the stock values from the peak to trough as measured by MSCI China All Share Index. The index is now trading at 15.7 P/E in end 2021 for an expected EPS growth of 16% in 2022. In comparison, the S&P500 Index is trading at 22.3x P/E in end 2021 for an expected EPS growth of 7.5% in 2022.
Across China, valuations are now much more attractive than at the start of the year, in particular when compared to US equities and considering that the two countries are likely to enter different monetary dynamics. The expected easing cycle in China should make Chinese equities more attractive while the US tightening cycle might create headwinds for US equities (although it will depend on the strength of US EPS growth).
Chinese Equities yields versus US Equities yields
Source : LOIM as on December 8, 2021
According to the 2019 UNCTAD Digital Economy Report, the digital economy, in the broadest sense, represents 30% of China’s GDP versus 21.6% share in the US and 15.5% in the rest of the world.
The most recent 14th Five-Year Plan (2021-2025) and Vision 2035 set out ambitious goals and can foster a range of investment opportunities in numerous sectors, especially technology and the digital economy. The Five-Year Plan aims to exceed 5% annual growth in R&D investment, which will help advance high-tech industrialisation, robotics and automation. Authorities are also focused on advancing new technologies: 6G, digital sensors and communications networks for smart-city development, and the formation of a national data-centre system.
Given the critical role technological innovation plays in shaping the nation’s economic plans, we believe investment opportunities should arise as companies adapt to the new cybersecurity rules and compete on a similar regulatory footing as their Western counterparts.
Looking ahead
To conclude, we believe investors should stay focused on the big picture and not allow short-term volatility driven by modernising regulations and investor flight obscure long-term opportunities in China. In the nation’s tech sector, these prospects are being generated through by a combination of pro-growth policy flex and cheap valuations.
Discover more about our China high-conviction strategy here.
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