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- Policymakers pivot to ease rules for China's new economy sector to support its development
- China tech sector recovered some 20% after hitting bottom in Oct 2022
- Earnings quality of sector leaders have remained resilient despite Covid headwinds
- Announcements by top govt officials confirm the easing of policy crackdown on platform companies
- China's new economy sector preferred as growth booster in the CIO Barbell Strategy
Government easing policy on New Economy Sector. After some 20 months of policy crackdown on the new economy sector, China’s regulators have pivoted to easing the rules in a bid to support the development of this colossal and strategically important sector.
Since the start of strict policy implementation, China’s technology equities plummeted some 60% between February 2021 and October 2022 (Figure 1, period a) as investors bailed out of their exposures. This resulted in an obvious divergence where stock prices corrected in spite of resilient earnings.
Post China’s Party Congress, things took a decisive turn for the better when policymakers started to pivot from their previous policy stance and introduced a series of supportive measures for the sector, which was in line with our expectations.
Subsequently, China equities and China’s technology sector in particular, saw an encouraging recovery and the latter’s stock prices rebounded some 20% since the end of October (Figure 1, period b). This comes on the back of encouraging developments, namely easing of policies, senior officials expressing support for Internet firms, and an announcement of material plans to revive growth of the digital industry.
Figure 1: China Technology - divergence in stock prices and earnings forecast unjustified
Source: Bloomberg, DBS
Importantly, throughout the past two years, fundamentals of China’s new economy sector have remained resilient notwithstanding the Covid lockdowns, policy tightening, and headwinds confronting domestic consumption. Looking at five listed new economy firms which have at least 10 years of listing record, on aggregate, their revenue and profitability have proven to be resilient even during the pandemic. Now, with policy tightening in the rearview mirror, we anticipate the sector will shine again.
Existing investors are well-positioned to benefit from this recovery, while investors not yet exposed to this sector should seize this window of opportunity to capture its upside potential.
Tailwinds from policy support. Senior policymakers from high-level government agencies have openly expressed their stance in the past few weeks to support the success of China’s digital economy and companies operating around the eco-system.
Ripe for rerating. We expect China technology and new economy sectors to bottom at current levels and recover, catalysed by the following:
- Forward PER of the technology sector is at a multi-year low and hovering at -2 standard deviations to mean. This is unjustified given the double-digit forward earnings growth among bellwether new economy companies.
- Price-to-book at -1.5 standard deviation to mean, similarly at a multi-year low.
- Close inverse correlation with US bond yields. With most of the US rate hike cycle largely priced in, the sector should find a bottom at this level, paving the way for a longer lasting rerating.
Recommendations. Amid this compelling backdrop, improvement in the operating environment, emergence of new regulatory support, and favourable risk-reward tilt, China’s new economy sector is among the preferred expressions as growth boosters in the CIO Barbell Strategy.
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