Sentiment has improved and Ark Invest is endorsing JD.com
Sentiment has recently lifted considerably from very low levels in Chinese technology stocks as large technology investors such as Cathie Wood has come back to Chinese technology stocks and companies such as JD.com delivered better than expected earnings on Monday. Yesterday, Pinduoduo posted its first quarterly positive net income and said that it would distribute $1.5bn in profits to Chinese farmers over time in line with the indirect wish of China under the ‘Common Prosperity’ principle. Today, Xiaomi and Kuaishou Technology have both reported stronger than expected earnings again bolstering the view that maybe regulation is here in voice but in terms of action the impact is minimal. Also, the PBOC has communicated that it is willing to support the Chinese economy and today the central bank intervened in the repo market, suggesting that China might soon loose its fiscal and monetary policy.
Echoing what we have been saying for a while, Cathie Wood explained in a Bloomberg interview yesterday, that investing in Chinese technology stocks in the future is about finding companies that are aligned with the strategic objectives of the Chinese government. That is why Ark Invest is now again investing in JD.com because they see it as a positive force in the Chinese society building out local logistics infrastructure. Likewise we have argued that companies such as Xiaomi and ANTA Sports are part of the consumer economy and a positive for the Chinese government. But one thing is consumer stocks in China another and much more importantly, is it time to technology stocks again?
The Party Congress and valuation discount
Before ploughing into Chinese technology stocks investors should recognise that China’s next Party Congress is set for October 2022 and thus the political sphere could continue to cast a shadow over the Chinese equity market. The main objectives for China are to clean the environment, reduce inequality, become self-reliant across key technologies such as semiconductors and renewable energy, and ensure that technology companies do not become too powerful reducing competition. That is the political dimension.
If we look at the 12-month EV/EBITDA valuation metric we can see that the Hang Seng Tech Index has gone from trading at a significant premium to discount relative to the Nasdaq 100 Index. Given the political uncertainty, delta variant in a zero-case policy framework, and financial leverage per Huarong and Evergrande, justifies a valuation discount for now in Chinese technology stocks. Our general view is that it will take time for foreign investors to come back and the “tail-risk” that has happened in Chinese technology stocks will not be easily forgotten by investors. As long as Chinese technology stocks trade at a discount to US technology stocks investors should focus on Chinese consumer stocks rather than technology stocks. For the short-term traders with a high risk tolerance going long Chinese technology stocks can be an option.