After Tencent’s profit slump, Chinese tech may trigger a bigger crisis in global markets than the Turkish lira
Nicholas Spiro says a Chinese tech-induced sell-off in the US stock market could do significantly more damage to broader sentiment than the Turkish currency crisis
For currency investors, there is little doubt about the source of the latest shock to roil markets. The collapse of the Turkish lira, which at one point last week was down more than 40 per cent against the US dollar, is seen as the chief problem, putting further strain on other emerging market currencies and raising fears of financial contagion.
Yet in the equity markets of developing economies, a different narrative was driving investor sentiment last week, one with significantly more potential to influence the direction of the all-important US stock market which, as I explained in an earlier column, has outperformed rival markets this year in spectacular fashion.
Last Wednesday, Tencent Holdings, China’s technology giant and one of the world’s top 10 companies by market value, stunned investors when it reported its first drop in profits in more than a decade as its online gaming division – which accounts for over a third of the firm’s revenues – faced a regulatory freeze on new game approvals.
Tencent’s shock profit slump caused a sharper one-day fall in the MSCI Emerging Markets Index – the leading equity gauge for developing economies – than on the day Turkey’s currency crisis erupted.
The greater sensitivity of emerging market equity investors to Tencent’s travails stems from the composition of the benchmark index.
Turkish stocks have a less than 1 per cent weighting in the index while Chinese equities, which now include 226 mainland-listed shares, account for more than 31 per cent of the gauge. Tencent itself is the largest component of the index and together with China’s two other tech giants, Baidu and Alibaba, are known as the BAT stocks and make up one-tenth of the index.
Put simply, the performance of emerging market equities is closely tied to the fortunes of China’s tech behemoths.
What is more, the woes of Tencent – its stock price has plunged almost 30 per cent from peaks in January, compared with an eye-popping 114 per cent rise last year – come at a particularly sensitive time for the Chinese market, the broader US-led tech sector and the emerging market asset class.
According to the latest global fund manager survey published by Bank of America Merrill Lynch last Tuesday, a long, or overweight, position in both FAANG – the five US tech giants, Facebook, Apple, Amazon, Netflix and Alphabet’s Google – and BAT was the most popular trade in markets for the seventh month in a row.
Yet strains on China’s tech stocks – the shares of Alibaba and Baidu are down about 16.5 per cent and 18.5 per cent respectively since mid-June – threaten to bring out vulnerabilities in the US tech sector, which has turbocharged the rally in America’s equity markets, a run which on Wednesday will officially be the longest in history.
This year's strong gains in US tech stocks have led to a marked divergence between the FAANGs and the BATs – the MSCI China tech subgauge, which surged nearly 80 per cent in 2017, is in negative territory for the year and is currently trading at its lowest valuation relative to its US equivalent in nearly seven years, according to data from Bloomberg. Yet, the New York Stock Exchange’s FANG+ Index, a closely watched tech gauge that includes FAANG and BATs, is down more than 8 per cent in the past month, with more than a third of the decline occurring since Tencent reported its poor quarterly figures.
Make no mistake, a more severe Chinese tech-induced sell-off in the US stock market could do significantly more damage to broader sentiment than the Turkish currency crisis.
First, it could act as a catalyst for a sharper unwinding of the tech trade which has been one of the most important factors in the resilience of US assets. Investors are already concerned about the future growth prospects of some of the FAANG, with a staggering US$120 billion wiped off the value of Facebook’s shares on July 26 due to concerns about slowing sales growth.
Second, growing nervousness about Chinese tech stocks – and the regulatory and political risks confronted by the sector – adds to the plethora of concerns about the Chinese markets and economy, the most important determinant of sentiment towards developing economies. While other sectors in China’s battered equity markets, notably banks and real estate, are trading at low valuations, tech stocks remain expensive, increasing the scope for further declines.
Turkey’s currency crisis will doubtless rumble on, but it is souring sentiment towards Chinese tech stocks that pose a bigger threat to global equity markets.
Nicholas Spiro is a partner at Lauressa Advisory