What's next for Chinese tech?

The entrepreneurial vision in China along with state-backed funding has led to one of the fastest growing and vibrant start up scenes in the world, rivaled only by that of Silicon Valley. China's tech sector, under the government initiatives of “Internet Plus”, “Made in China 2025”, and “Outline on the National Information Technology Development Strategy”, is emerging as an innovation and technology powerhouse.

Year-to-date, however, the Chinese tech sector has significantly underperformed its US counterpart. At the beginning of the year, the biggest issue weighing on Chinese equities was the government’s financial de-risking campaign and quasi fiscal moderation. In order to try and de-risk its economy, China has been on strict path to deleverage, with stricter financial regulation and rules to curb shadow banking and misallocation of capital to non-productive areas of the economy. Add to this trade frictions, slowing economic growth, tightening US monetary policy, and a stronger dollar, and we see a perfect storm in Chinese equity markets that has sent them into a tailspin since the beginning of the year. 

As economic data began to cool off and miss estimates, the Chinese government pre-empted a growth slowdown and stepped in in to ensure economic growth was not compromised. A double-barreled fiscal and monetary easing campaign has been enacted. There have already been three reserve ratio requirement cuts this year (with more expected), record medium-term lending facility liquidity injections, and a fiscal stimulus package including 65 billion yuan in tax cuts, expanding the preferential policy for small firms to all firms plus an infrastructure spending package all aimed at boosting domestic demand.

All this signals a policy shift towards easing, which is likely to support growth momentum in China for the time being – something that markets may be underestimating at the moment. Although the policy efforts introduced so far do not amount to broad-based easing as seen in 2009, these measures should not be underestimated.

The valuation of Chinese tech has been extreme relative to the US. As the graph below shows, historically a basket of Chinese tech companies trades at a valuation premium to US tech when comparing P/E ratios due to stellar growth. Now that actual growth is no longer meeting expectations we are seeing a repricing across the sector as a whole. The market is revaluing Chinese tech stocks based on a slowing growth trajectory rather than a structural problem within the sector. For example, Tencent shares fell 6.67% in the US after reporting weaker than expected numbers but it is still one of the fastest-growing technology companies in the world, as Saxo bank Head of Equity Strategy Peter Garnry recently pointed out.