Recent market sell-off and outlook on China tech

Recent Tech Market Sell-Off

There are a few reasons why the Chinese tech sector may have sold off recently, conversely there are many convincing reasons why this may be the time to opportunistically consider an unloved sector.

The A-share correction over the past few months has predominantly been driven by fund flows out of the onshore market as domestic investors became risk-off and pulled RMB 1trn from equities into money market funds, a 13% q/q increase. A surging Chinese stock market in 2020 led to a few stellar months of record fund flows from September 2020 – January 2021, driven by retail investors and new fund issuances hoping to jump on the band wagon. This in turn may have inflated certain sectors early on in 2021 as fast money chased easy returns in high growth companies.    

The Chinese equity market has experienced such downward movements before, in Q3 2015, Q2 2017 and Q1 2020, the latter due to the outbreak of the pandemic. Each downdraft has likely been caused by domestic investor risk aversion as households moved money to savings from equities.

While growth sectors such as technology and communication services have underperformed relative to other sectors on a YTD basis, the recent sell-off has not been exclusive to the technology sector. In fact, all sectors except for energy, materials and utilities have registered negative returns since the start of the month.

One of the narratives surrounding the risk-off environment during Q1 has been fears of domestic monetary tightening, which may be somewhat overblown. Even though broad money growth (M2) only grew 9.4% y/y in April - a 1.5% decline from the same period last year, the PBOC still forecasts money growth to be around 11% y/y in 2021, the same level of growth as last year. It’s possible that monetary conditions tighten a bit later this year as the economy steams ahead, though the PBOC has reiterated that there will not be any sharp shifts in monetary policy this year and conditions will remain accommodative. 

Another reason why we saw downward pressure on technology stocks came from the stern warnings issued by regulators against speculative investment, causing retail investors to grow cautious. Looking back, these warnings applied mostly to the surging residential real estate market and certain overbought stocks.

The primary reason for the technology sector’s recent underperformance is likely due to the regulatory oversight actions taken by policymakers. It is unlikely that the regulators intend to maim or permanently impair certain companies or sectors, instead we believe these actions are a determined effort by regulators to level the domestic playing field in order to ensure a competitive landscape that fosters constant innovation.

Regulatory oversight has happened before to many Chinese industries and most recently we’ve seen oversight in the video game, e-commerce, fintech and online education sectors. In China, policymakers initially give sufficient leeway and support to growth sectors in order for them to thrive – however once they can stand on their own, it’s only a matter of time that regulators come in to establish norms and rules.   

Outlook on the Chinese Technology Sector

There are a few near-term risks that could dampen risk appetite for the Chinese technology sector, although we believe the risks have been well discounted by now. Firstly, we do not think that the technology sector – particularly electronic platforms, fintech and online education companies – are out of the regulatory oversight woods yet, although it appears as though the worst is over for many of them.

Secondly, certain technology sectors may continue to come under fire as the US tries to minimize China’s ability to procure fundamental technologies from abroad. This has already been a major headache for certain Chinese semiconductor and hardware companies, although the supply-chain issues are not insurmountable. While the Chinese government has laid out a target to achieve 70% self-sufficiency via its Made in China 2025 policy, its estimated that China’s self-sufficiency ratio for semiconductors will only reach 19.4% by 2025. Geopolitical risks are fluid and dynamic, and it’s possible that a more constructive environment could be reached as full US-China technology decoupling fears abate for now.

Despite these near-term risks, the longer-term outlook for the technology sector appears bright. China’s aging demographics will necessitate the economy to become more productive and efficient. This is a positive structural catalyst for the technology industry as digitization trends remains a significant tailwind for the sector. Even with a greying population, the population size remains an asset with a significant number of investment opportunities.  

In particular, we remain constructive on specific technology sectors such as hardware, software, electronic payments and advanced engineering machinery. Also attractive are technology companies catering to China’s youth – who are digitally inclined, patriotic and gravitate towards local brands.    

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

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