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Why China and US tech stocks are diverging

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U.S. and Chinese tech giants’ stock have been on an upward path — until this year.

Since June, there has been a nearly 50% performance gap between China and U.S. internet stocks. While FANG (Facebook, Amazon, Netflix and Alphabet’s Google) stocks are sending the S&P 500 to record highs in its longest bull market, Chinese internet stocks are down along with the Chinese domestic equity market and its currency, the yuan.

(Screenshot/JP Morgan research)

Since the beginning of this year, billions of dollars of market value have been wiped out from China’s largest tech giants — Baidu, Alibaba and Tencent, known as BAT. Shares of Tencent (TCEHY), China’s largest social media and gaming company, plunged almost 30% from its peak in January, after an eye-popping 114% rise in 2017. Alibaba stock (BABA) has pulled back 20% from its June peak, and bounced back a bit after Thursday’s earnings report.

So far, the Invesco PowerShares NASDAQ ETF (QQQ), an exchange-traded fund based on the Nasdaq-100 Index with major holdings in Apple (AAPL), Amazon, Microsoft, Alphabet and Facebook, has had a strong year with 14.2% growth. The Invesco China Technology ETF (CQQQ), which holds big tech names in China, including BAT, however, recorded a 20.7% drop.

ETF CQQQ and QQQ (Yahoo Finance)

The massive performance divergence is a reflection of investors’ concerns over a slow down in the Chinese economy, which has dragged down the emerging market index across the board. Since the trade dispute between Washington and Beijing escalated in February, the Shanghai Composite Index has dropped by 17.3%, and the yuan has fallen sharply against the dollar, once trading close to a rare level of 7.

The trade war and U.S. government’s increased scrutiny on direct tech investments from China have contributed to the selloff, according to Jun Bei Liu, portfolio manager of Sydney-based Tribeca Investment Partners.

FANG stocks have benefited from their Chinese counterparts’ volatile run. This year, stock investors reduced emerging market and Europe exposure and added U.S. equities to their portfolios, which they see as safer destinations to park money. The moves are creating a shortage of U.S. stocks.

“As the Fed is creating a shortage of U.S. dollars, and Trump’s trade wars and sanctions are further boosting the USD, the U.S. stock market attracts more investors,” JPMorgan analysts wrote in a note on Wednesday. Since April, $100 billion has been added in equity exposure, mainly in U.S. equity indices.

“Tech sector [in China] had previously been the large beneficiary of such large inflow, now it is seeing the reverse,” Liu told Yahoo Finance in an email.

Fundamentals haven’t changed much, but risks remain

Chinese tech giants could face intense pressure from the government.

With ongoing trade negotiations between the two largest economies, analysts expect headline risks to haunt the Chinese tech sector for a while, while business fundamentals will see a limited impact.

Kevin Carter, the founder of EMQQ, an emerging market-focused tech ETF, argues China’s internet sector is doing fine with about 35% revenue growth, and consumers’ robust needs for technology is unlikely to change even in a trade war scenario.

“Trade disputes will affect things like steel, tires and chicken feet, not Chinese people using their smartphones for purchases, ride-hailing, travel, ordering food from restaurants, renting bikes,” Carter told Yahoo Finance. “Valuations of about 28 times PE are very compelling when revenue growth is considered.”

But risks remain for Chinese tech giants. Baidu’s (BIDU) investors fear that Google could come back to China with a censored search engine. And Alibaba, the most shorted equity in the world, has largely been seen as a proxy to bet against the Chinese economy, tying its performance to the macro narrative even closer.

The biggest uncertainty in the sector is the Chinese government. While U.S. tech giants like Facebook started to face more government scrutiny this year, the Chinese government controls homegrown giants at a different level, from censoring online posts to monitoring users’ privacy. Tencent’s online gaming division has faced a regulatory freeze on new game approvals. And its shares tumbled 4% in one day after a state-run newspaper called its most popular game “poison” to young people in July 2017.  

The government wants to cultivate valuable companies as an engine for tech innovation and economic growth, but also want them to behave and fit into the party’s agenda. These unpredictable headwinds could abruptly reduce growth forecasts in an otherwise strong year.

“There are many areas that those tech companies can run afoul of the government, whether it’s censorship, moral pollution or making too much money,” Shaun Rein, managing director at China Market Research Group, told Yahoo Finance. “The Chinese government has chosen some national champions like Tencent and Alibaba, because they do whatever the government wants. Long term they are the safe bet, but there are short-term ups and downs.”

Krystal Hu covers technology and economy for Yahoo Finance. Follow her on Twitter.

Read more:

The real reason why traders are shorting Alibaba

How Apple succeeded in China, where other tech giants have failed

Inside Amazon’s little-known graphic T-shirt-making business

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Written by Quad Oner


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