Time to Revisit China Tech

Read  June, 2021 edition: China 2H 2021 Outlook – Ready for a Rebound?

Fed tapering: Should Powell focus on limited margin for error or on inflation?

In conjunction with the US Federal Open Market Committee (FOMC) meeting held on June 15-16, the US Federal Reserve (Fed) surprised the market with the median forecast of two rate hikes by 2023, up from zero predicted in March 2021. The immediate market reaction was a flattening yield curve (financial stocks corrected sharply), growth outperforming value, and further profit-taking on reflation beneficiaries. After the Fed dot plot surprise, market consensus now believes that the Fed shall begin to taper quantitative easing (QE) by 1Q2022, with the talk of tapering starting at the September FOMC meeting and the first rate hike in 1Q2023. Investors generally think this round of tapering (compared with the 2013-14 episode) will provide fewer negative surprises for the market because:

i) it has been well-telegraphed and hence would not be a surprise to the market; and

ii) market positioning in both the foreign exchange market and credit leverage do not appear to be excessive, implying unwinding activities are unlikely to be disruptive.

What history tells us on US Fed tapering?

Fed Chairman Ben Bernanke’s mention of tapering on 22 May 2013 shocked the market although he has not implemented the shift until he called an end of QE during the 29 Oct 2014 FOMC meeting. During the initial phase of the tapering period (1 May 2013 – 1 September 2013), key observations are:

- The Hang Seng Index outperformed both MSCI Asia ex-Japan Index (benchmark index) and the CSI300 Index, while underperforming the S&P 500 Index (Chart 1);

- In terms of sectors, technology, healthcare, consumer discretionary and telecommunications were the key outperformers in Asia (Chart 2). Of which, China technology (MSCI China Information & Technology Index) outperformed the benchmark by 38.6%, which was the second highest within Asia after MSCI India Information and Technology Index’s 50.0% relative performance); 

- On the foreign exchange front (Chart 3), the CNY appreciated throughout the initial tapering period whereas the Asian dollar index (Bloomberg JPMorgan Asia Dollar Index (ADXY) is used as a reference) depreciated vs. both the CNY and the USD, as it was mainly dragged down by Southeast Asian currencies (mostly by INR’s -22%, IDR’s -12% and THB’s -10%).

Why do we think this time it is different?

Compared with the 2013 tapering episode, from a Hong Kong-China equity market perspective, we believe there are two main differences, which should make the current tapering effect less disruptive than before:

i) influence of Chinese money in the Hong Kong stock markets have increased significantly over the past 10 years, especially since the Hong Kong-China Connect Scheme was launched. Generally speaking, Chinese liquidity is less correlated to the US rate cycle;

ii) with the COVID-19 backdrop, the Fed (as well as global central banks) has limited room for error; therefore any adverse growth outcomes could trigger an immediate shift in central bank rhetoric back to a more dovish mode.

What to invest in before the September FOMC meeting?

Commodities are oversold: We remain positive on non-ferrous metals, especially copper and aluminum, because they are underpinned by structural reasons (e.g. an increase in infrastructure spending, Greenfield projects on clean energy etc). We note that some investors are concerned about the high copper price hurting downstream margins. For example, machinery and home appliance makers are seeing a margin squeeze. The market consensus view is that there may not be much the Chinese government can do to influence the copper price, given that this is a function of global pricing. According to mymetal.net, as of end May 2021, copper reserves are estimated at 1.8-2mt, equivalent of only 1.7 months of consumption. Market participants are commenting that as a country short of this critical commodity, China would need to rebuild its reserves swiftly, making it a zero sum game, with the government intended to keep its copper reserve above 2mt.

Re-opening, reflation theme remains intact: Two key reasons for the re-rating of Hong Kong developers and retail landlords are economy re-opening as a result of COVID situation stabilisation, alongside with asset reflation. Of which, we see further upside potential on the Hong Kong retail landlords in July 2021 on the back of Hong Kong government’s announcement of details on HKD 5000 electronic Consumption Voucher Program for each eligible Hong Kong permanent resident aged 18 or above. This scheme involves a financial commitment of HK$36bn and is expected to boost the economy by 0.7%.

Adding tech element to healthcare: We think technology innovation is one of the important determinants for online healthcare success. Of which, we think clinical decision support system (CDSS) is one of the major focuses recently for all the major players. We believe CDSS is close to the point of being commercially deployed at a nationwide scale, as it is in line with the Chinese government’s healthcare digitalisation agenda. Key objective of CDSS is to drive up online patient traffic and consultation volume significantly so as to alleviate the existing physical consultation supply bottleneck. Once CDSS becomes mature, all the major online healthcare players should see a significant margin enhancement.

Upgrading Technology to Overweight: We turn more positive on the China internet sector because:

(i) valuations are more reasonable after correction YTD;

(ii) key concerns on regulation around antitrust and fintech sector are being priced in;

(iii) there are subsectors with catalysts in the 2H 2021 e.g. mobile game companies are expected to launch high profile titles in the coming months;

(iv) investments in new ecommerce initiatives are already well expected, with stocks likely to show positive momentum as we pass through quarterly peak losses;

(v) as China macro growth momentum decelerates in 2H 2021, we expect interest in secular growth names to be rekindled.

Since our downgrade in February 2021, Hang Seng Tech Index has corrected by ~30%. Standing at 24x 2022E P/E, valuation has reverted to a more reasonable level, hence we believe most policy risk and earnings slowdown have been priced in.

However, we remain selective on policy-sensitive sub-sectors such as ecommerce and fintech. Select consumer tech with low policy risk (or even supportive policies), such as electric vehicles (EV) and online healthcare (medtech), remain our top selections.

CONCLUSION

(i) Impact of the forthcoming tapering is expected to be less disruptive than the 2013 episode.

(ii) We have upgraded China internet sector to Overweight, as valuation has become more reasonable now (22x P/E) and policy risks are largely priced in. Meanwhile, both macroeconomics and corporate earnings are demonstrating positive momentum.

(iii) However, we remain selective on policy-sensitive sub-sectors such as ecommerce and fintech.