19 July, 2021
Our quant team has run the numbers on the growing divergence between meg-cap tech stocks in the US and China.
In the 12 months to Friday’s close in the US, an equal-weighted basket of China’s three internet giants (Baidu, Alibaba and Tencent) returned +11.89%, while an equivalent portfolio of US peers (Facebook, Amazon, Apple, Microsoft and Alphabet) has risen +38.39%.
Recent events regarding Didi (China’s answer to Uber) indicate just how fluid the regulatory environment remains. Two days after Didi executed the second largest US IPO by a Chinese company, the Cyberspace Administration of China launched a probe into Didi’s data security, resulting in the company’s apps being removed from app stores in China.
China is in the process of implementing new regulations in three key areas; to restrain monopolies, govern fintech firms and protect data privacy and security. There will be greater supervision over Chinese companies listed overseas and rules for overseas listings may be revised.
China ultimately wants its leading companies to be accessible to Chinese domestic investors via listings in the mainland or Hong Kong. This seems sensible and positive at most levels and has been happening for some time, initially in response to US legislative threats.
Clearly this uncertainty is not good for short-term sentiment, and it may take time to dissipate. However, over the long-term the bigger picture for Chinese big tech remains positive, particularly for those companies that benefit consumers by increasing e-commerce penetration into lower tier cities and modernising fresh food delivery. Digital advertising also remains a major growth opportunity in China.
While the risks can’t be ignored and must be factored into valuations, in our experience regulatory concerns, all else equal, can allow incumbent companies to build even higher barriers to entry and have also proven to create sound buying opportunities. We saw this in recent years with Facebook.
Tencent is an example of a top 10 holding in the APL portfolio we added to while it materially de-rated amidst the increased regulatory scrutiny and uncertainty.
To be clear, it’s not only outside of the US where we see value in big tech. Facebook and Microsoft are long term top 10 holdings.
Like Tencent they are dominant incumbents and right now are valued at a discount relative to smaller competitors and cheap relative to their own growth profiles.
The one big question on the ‘market rotation’
As growth stocks pushed the tech-heavy NASDAQ and S&P 500 to new record highs last week, much of the investor and media hype we saw earlier in the year around the ‘great value rotation’ appears to have allayed.
The question to be asked is with data across the major economies indicating economic activity has returned to trend levels, can the current cycle that’s been supporting low-multiple stocks extend thanks to excess savings and pent-up demand?
Well, in the US, household disposable income excluding stimulus is 6% above pre-COVID levels, while spending is 5% above pre-COVID levels – and the country is still reopening.
Excess savings from COVID-related stimulus and underspending is equivalent to 17% of current household spending, so it remains our view that households have never been in a stronger position to continue consuming above trend, supporting the cycle in the near term. If consumption surprises on the upside, so too could near-term inflation, which last week printed 0.9% growth relative to the prior month – double consensus expectations.
This was the biggest monthly increase since August 2008. We don’t see core inflation peaking until late next year.
Further, the continuing emergence of a self-sustaining investment cycle can see a much more durable, long-term rotation into low-multiple stocks. In this vein, we’ve recently discussed historical levels of infrastructure spending and the decarbonisation super cycle.
There are however risks, especially in the US where the economic recovery is already well priced by the market.
Something investors should pay close attention to is the job market in the US. If it hasn’t fully normalised when stimulus expires in September, excess household savings could remain unspent. In this case, consumption could slow just as economies are fully reopening and supply chains are normalising. The danger is the economy slows before any investment-led recovery gains traction.
As active global investors we can manage these risks by investing in resilient businesses at the right price.
A stock in focus | Tencent
Tencent is a digital empire that is embedded in the everyday life of the Chinese consumer. The core social messaging app WeChat, which is China’s largest social and messaging platform, has been leveraged to offer users media/entertainment content, e-commerce, payment and financial services solutions to name a few.
Penetration of digital advertising remains low in China, lagging that of the US as a percentage of GDP. As such WeChat is hugely undermonetised relative to time spent. Tencent’s ability to collect data and build a user profile is perhaps one of the best in the world, and the company will be able to monetise this as the digital advertising economy grows.