My role as chief equity strategist keeps me in constant contact with BlackRock investors around the world. I had an opportunity in September to join eight colleagues on a company tour in China. We met with 20 technology, media and new economy companies—13 public and seven private. Their businesses and ambitions ranged from the fast-growing and fundamental (think electronic vehicles) to cutting edge (facial recognition powered by artificial intelligence).
The trip was eye-opening on many levels. For one, I left with a new appreciation for Chinese hot pot after my first trip to a wildly popular restaurant that, incidentally, just went public. Wait times are long, but not boring—they offer snacks and entertainment, from board games to free manicures. It’s an innovative business model that has consumers coming back for more.
More germane to the topic at hand: I left with a fairly optimistic outlook on the medium-term opportunities in China’s largest and fastest-growing sector: technology. This is also the very sector that had been leading emerging market indexes down for the year. Among my key takeaways:
Chinese tech is unique.
The sector is not composed of companies that simply replicate the U.S. tech leaders, but rather is composed of an array of businesses that tailor experiences and services for the distinct demands of domestic users. One key differentiator: Chinese Internet and tech companies have skipped the process of developing web-focused content and went directly to building apps and tailoring services for mobile. Competition is fierce, incumbents are frequently being challenged, and the sector continuously disrupts itself. The Chinese are embracing technology to offset rising labor costs and the pressures of aging populations. Their commitment is strong. They are devoting considerable financial and human capital resources to the development of artificial intelligence, a key strategic priority, and are on their way to becoming a global leader in this high-potential space.
Investor takeaway #1
The Chinese tech sector has grown significantly in the past decade, as shown in the chart below, and has more wind at its back amid broad support domestically. This could bode well for future growth and performance.
A rare silver lining to U.S.-China tensions?
Trade frictions and the competition for tech dominance are clear concerns for the market, as our BlackRock geopolitical risk dashboard shows. But there may be a bright side. We see U.S.-China tensions and an extension of investment restrictions stoking rivalry-fueled innovation in both countries and resulting in less co-development. The de-coupling of the two global technology leaders will likely lead to distinct investment opportunities. See our related blog post. Even before the escalation of trade tensions, China had already committed to making progress on vertical integration within the tech supply chain for critical components like semiconductors (now primarily imported from the U.S.) and to reallocate capital to the tech sector as it grows its ambitions.
Investor takeaway #2
It may make sense to make room for both U.S. and Chinese tech in your portfolio to achieve the greatest diversification benefits.
Regulation in the rear-view mirror?
2018 was a big year for regulatory and policy changes in China. This imposed a drag on activity and revenue for tech and media companies, many of which had grown unfettered and unregulated in years prior. Chinese tech earnings were up 56% in 2017, IBES data show. The year of policy catch-up has been painful. Earnings estimates were revised down throughout 2018–and prices followed. Policy disruption is not over yet, but the companies we spoke with see it as a net positive longer term, setting the stage for greater stability and a more robust future. And with the bulk of policy changes in the past and companies having put processes in place to adapt, the consensus earnings outlook is brighter for 2019.
Investor takeaway #3
Valuations for Chinese tech companies fell this year amid U.S.-China tensions and domestic regulatory scrutiny. But a brighter outlook for 2019 may make this a good time for long-term investors to dip their toes into Chinese tech at more attractive levels.
None of this diminishes our vigilance. We fully expect volatility in Chinese tech in the short to intermediate term. We’re approaching the opportunities in China with eyes wide open, cognizant that the economic growth outlook is a concern and tensions with the U.S. pose multifaceted risks. Yet we see the fundamental foundation in place for a robust tech sector longer term. To read more about the potential opportunities and risks in Chinese tech stocks, see our Global equity outlook: The heat is on for tech stocks amid U.S.-China cold war.