The heat is on for tech stocks amid U.S.-China cold war - BlackRock
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FOR INSTITUTIONAL, PROFESSIONAL, WHOLESALE, QUALIFIED INVESTORS AND QUALIFIED CLIENTS. FOR PUBLIC DISTRIBUTION IN THE U.S. ONLY.
GLOBAL EQUITY OUTLOOK • NOVEMBER 2018
The heat is on for tech stocks
amid U.S.-China cold war
The U.S. and China are the two global leaders in technology, and the tech sector
is the largest constituent in both countries’ stock markets. Deteriorating relations
between the two superpowers, with tech dominance a key issue, are sparking investor
concerns. Recent selling has fanned the flames. We see a focus on innovation and
battle for supremacy as long-term positives for the tech sector in both countries.
Yet key differences – in everything from sector composition to performance and
Kate Moore valuations – call for a nuanced approach. We focus primarily on China, where a
Chief Equity Strategist, recent company tour provided valuable insight.
BlackRock Investment Institute
Highlights
• Price reset. Recent selling in both Chinese and U.S. tech stocks has been painful,
but we see it potentially creating more attractive entry points for long-term investors.
• Tech decoupling. We see U.S. and Chinese tech developing differently, a trend
amplified by changes in trade, cross-country investment restrictions and the
competition for dominance. This can mean two distinct opportunities for investors.
• Risk and reward. Chinese tech has lagged the U.S. in 2018 and valuations look
Lucy Liu compelling. Yet we are watching how trade disputes and strained relations affect
Research analyst, Chinese IPO activity, global supply chains and cross-border investment.
BlackRock Fundamental
Active Equity Performance picture
U.S. tech is still up 10% year-to-date despite October selling, while China tech has
plunged 28%, resulting in the largest relative performance disparity since 2004. See
the chart below. This partly reflects downward revisions to Chinese tech earnings.
Yet analysts project a rebound in 2019 amid strong demand, fiscal stimulus and
waning regulatory hurdles. We also see China’s focus on domestic demand and a
strategic commitment to self-reliance as potential positives amid trade disputes. U.S.
tech earnings, meanwhile, are expected to normalize after a boost from 2018 tax cuts.
Tough times for Chinese tech
Performance of Chinese vs. U.S. tech stocks, 2000-2018
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in
an index. Sources: BlackRock Investment Institute, with data from Thomson Reuters, October 2018. Notes: The dark
blue line represents the rolling 12-month performance of the China tech sector minus that of U.S. tech to illustrate out-
or underperformance. The horizontal lines represent the 75th and 25th percentiles of this series and show the current
level has been seen less than 25% of the time since 2000. Figures based on the MSCI USA and MSCI China indexes.
BII1118U/E-651057-2018970
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Two countries, two tech sectors Shrinking premium
The tech sector is growing in both the U.S. and China. See Chinese vs. U.S. tech stock valuations, 2008-2018
the Tech’s growing heft chart. Yet the two are quite different.
U.S. tech’s global focus is set against a domestic bent in
China – where three stocks represent the lion’s share of tech
market cap. Other distinctions: the market for tech services
is larger in China; the consumer base has a different income
profile; and the regulatory framework is developing faster.
Chinese tech is an innovative hub tailoring experiences and
services for a distinct domestic user. It is at pivotal points in
acquiring new customers and tapping into higher value
consumption, with many industries battling for market share.
Competition is fierce and the sector continuously disrupts
itself. Consolidation and acquisitions are common, but with
a recognition that purchasing new assets can weigh on profit
Sources: BlackRock Investment Institute, with data from Thomson Reuters, October
margins if user growth and ad revenues trail.
2018. Notes: The dark blue line shows the premium or discount of Chinese tech
Online services have grown in areas where offline services relative to U.S. tech based on forward 12-month price-to-earnings ratios. The
horizontal lines represent the 25th and 75th percentiles of the premium/discount since
are insufficient or inefficient, such as education, health care September 2008. Figures based on the MSCI USA and MSCI China indexes. It is not
and entertainment. The explosion of digital entertainment possible to invest directly in an index.
such as streaming video has filled the void left by limited
content from official media outlets. Tech is not always What’s worrying investors?
displacing analog solutions – high demand often compels Chinese tech stocks have underperformed this year, pushing
leaps directly to online service. Technology is also seen their typical premium to U.S. tech near its lowest this decade.
as a solution for rising labor costs and aging populations. See the Shrinking premium chart. Risks to growth and
The Chinese are devoting considerable resources to the consumption, alongside geopolitics and trade uncertainty, are
development of artificial intelligence, a key strategic priority, reasons. Our BlackRock geopolitical risk indicator (BGRI)
and are on their way to becoming a global leader in the space. shows U.S.-China relations and global trade tensions are the
two worldwide risks gaining the most market attention – and
Meanwhile, the U.S. maintains its stronghold in enterprise the effects are starting to feel more tangible. We’ve seen
software and cloud services. It remains the global leader in delays in order volume and timing for hardware equipment
semiconductors, though China’s ambitious plan to supply manufactured in China, for example. Companies are even
the majority of its own chips looms on the horizon. Existing
contemplating shifting production to other ASEAN countries.
differences in the Chinese and U.S. tech sectors are
magnified by U.S. changes to cross-border direct investment. China may be willing to compromise with the U.S. in seeking
If Chinese companies cannot invest in U.S. tech and U.S. to reduce the bilateral trade deficit. But rivalry in the tech
firms were similarly restricted in China, chances of co- sector and disputes over market access are likely to persist
development (as well as direct competition) fall – and the and raise the specter of tech fragmentation. This stokes
likelihood of separate protocols for key technologies rises. speculation over potential “winners” and “losers,” yet it could
also open the door to the emergence of distinct opportunities
Tech’s growing heft for investors. Another uncertainty: A possible digital services
Tech weight in U.S. and China markets, 2008 vs. 2018 tax on foreign tech firms in the UK and other countries.
Other obstacles make fewer headlines: Regulatory and policy
changes in China have had a big impact on the activity and
revenue for tech and media companies this year. Chinese tech
earnings were up 56% in 2017, IBES data show, as companies
grew unfettered and unregulated. But 2018 has been a year of
policy catch-up. Most of the new regulation aims to create a
robust business environment over the longer term, even if
some of the changes have been painful. One case in point is
China’s large gaming industry: The government approved
licenses for up to 7,000 new games in 2017 and 2,000 more in
the first quarter of 2018 before halting new licensure, Chinese
media reported in August. The move had a huge impact on
the business lines of key tech companies. We expect some
Sources: BlackRock Investment Institute, with data from MSCI and Thomson
regulation will ultimately shake out smaller players who may
Reuters, October 2018. Notes: The bars show the weighting of tech shares in each find it harder to adapt, yet most companies we’ve talked with
market currently and at the end of 2008. Figures based on the MSCI USA, MSCI feel confident the changes will help secure a brighter future.
China and MSCI China A indexes. It is not possible to invest directly in an index.
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Reasons for optimism Money flows
A side-effect of the increased scrutiny and regulation of China and U.S. cross-border investment, 2000-2017
the Chinese tech sector has been the development of
government relations functions within companies across
the sector. Many companies are working to directly involve
both official institutions and state-owned enterprises in their
platforms and future planning. Chinese tech and media
companies know they need to partner with the government –
or at least have a productive dialogue – to succeed.
Most of the policy and regulatory changes on the social side
are aimed at improving the economy and social safety net.
Policy disruption is not over yet, but Chinese tech and media
companies overall are growing and expanding rapidly,
despite the tighter regulatory environment.
Sources: BlackRock Investment Institute, with data from Rhodium Group, October
Chinese firms have been increasingly tapping into the U.S.
2018. Note: The bars represent foreign direct investment, with green showing China's
for new equity capital. Chinese IPOs represented 20% of total investment in the U.S. and blue showing U.S. total investment in China.
all global IPO deals in the third quarter of 2018, with the
majority in the tech sector, data from Dealogic show. The What to watch, where to invest
Going public chart illustrates the trend since 2015. “New We like both U.S. and Chinese tech longer term, and believe
economy” companies – especially tech – have dominated investors who choose one over the other are forfeiting
the IPO market in Hong Kong, particularly after listing significant opportunity. A drive to innovate supports both,
requirements were loosened in late April. while cross-country restrictions could limit redundancy
and direct competition, setting up distinct opportunities.
The China Securities Regulatory Commission also
liberalized listing rules this year to pave the way for more Where to look? We advocate digging deeper than the largest
domestic tech sector issuance, easing regulatory obstacles three tech firms in China to find value in a range of software
such as mandatory profit requirements. Listing reforms on and services. This makes active stock picking key. We believe
both the mainland and Hong Kong should open the door for valuations may be nearing bottom after lagging U.S. tech in
even more tech IPOs, in our view. 2018. Policy changes along with lofty initial expectations led to
downward earnings revisions in 2018, but 2019 could see a
Chinese tech valuations have fallen this year, while our
rebound: Companies are adapting to new regulations, and
BGRI shows attention to the U.S.-China relations risk has
demand for content, software and services remains robust.
risen. We believe the potential opportunity and value in
Chinese tech firms may be under-recognized in their current Within the diverse U.S. tech sector, we favor software as a
share prices amid a heightened focus on strained U.S.-China service (SaaS), or software services distributed through the
relations, as well as regulatory change. For those with a cloud. Moving key systems to the cloud can lower companies’
long-term mindset and stomach for short-term volatility, costs and allow for more frequent and sophisticated system
we believe it may be an opportune time to step in. updates. Some U.S. tech stocks are trading at a premium now,
but overall valuations are in line with their five-year average.
Going public
China IPO listings in the U.S., 2015-2018 Changes to the MSCI’s Global Industry Classification System
(GICS) on Sept. 28 mean the tech sector looks different.
Internet companies fell out of information technology (IT) and
into the new communications services sector. This leaves the
new IT sector largely comprised of hardware and software
names. Sector investors may need to look to the newly named
communications sector for some high-growth opportunities
once classified under the IT label.
What to watch? Our eyes are on the IPO market for clues
as to how many (or few) Chinese companies are coming to
market. Trade tensions and strained relations may have an
impact on whether Chinese companies list in the U.S. Some
companies hit by regulatory pressure have been taken private
temporarily and then listed on China’s A shares market,
removing U.S. investors from the ownership pool. Meanwhile,
Sources: BlackRock Investment Institute, with data from Dealogic, October 2018. Chinese direct investment into the U.S. is on pace to decline
Note: The green bars show annual deal volume in USD billions and the blue line over 90% in 2018 versus 2017, October data from Rhodium
shows the number of deals in each year. Group show. The Money flows chart illustrates recent trends.
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